The Farm CPA
Paul is now part of the fourth generation in America that is involved in farming and hopes the next generation will be involved also. Through his blog he provides analysis and insight to farmer tax questions.
Law of Diminishing Returns
Jun 02, 2010
In my post yesterday, I indicated that maximizing your net return per acre is more important than getting the most yield per acre. One of our readers wrote a great comment regarding how his operation tries to maximize its yield to achieve the most net revenue per acre.
My post should have stressed that your farm operation should try to maximize your yield up to what I call the point of diminishing returns. For example, if you can increase your yield by an extra 10 bu. (for corn) by spending $15 on good seed or fertilizer, then your return at $4 corn is $40/$15, or 2.67 to 1. As you do your analysis for your farm, anytime this number is greater than 2, it makes sense to spend the extra money.
If the number is between 1 and 2, then you need to crunch your numbers and get comfortable with your probability of the extra yield happening. For example, if you think you can make an extra $20 per acre by spending $10, your ratio is 2 to 1; however, if the chance of this happening is 50%, your expected ratio becomes 1 to 1. At this point, you are simply at the break-even point and you are not receiving any extra to cover your overhead related to this extra cost.
If you were to chart your options related to maximizing your yield compared to your input costs, the return yield to cost would look very similar to the horsepower chart on my BMW motorcycle. As I add revolutions per minute, the horsepower output increases at about a 45 degree angle up to about 8,000 rpm. At this point, as I add more revolutions per minute, the horsepower output slightly increases and then as I get near the redline, the horsepower starts to drop off dramatically.
In your farm operation, try to determine where the extra yield maximizes the return to the bottom line.