Know Your Costs; Account for Value
One constant for ag business is that there are never two years alike. Uncertainty with inputs, yield variability and price volatility present challenges, as well as opportunities.
Depending on your situation, four inputs have gone up 30% to 70% in price during the past five years. Cash rents, equipment, seed and fertilizer are among the most costly individual line items. Collectively, these four items can easily make up 80% of your production costs. The challenge is to distinguish the difference between additional "costs" to your farm and understanding the "value" that comes back to your operation.
Land and cash rents have led the charge with annual double-digit price increases during the past five to seven years. Land costs typically range from 20% to 50% of a farm’s total production cost depending on location, if you rent or own, overall debt and the level of rent that you are willing to pay. If you own land debt-free, it’s still important to calculate a land cost at least equivalent to the opportunity cost. At a minimum, assign land costs at 10% of total production.
Plan to Profit. It’s critical to analyze and measure your expenses at a "high enough" level so that you don’t underestimate the price you need to cover all your expenses.
Equipment expenses are another line item that has increased significantly. I see many producers with much higher equipment investments than they had just a few years ago—to the tune of 50% to 70%.
Part of this increase is due to climbing equipment costs; however, most of the increase comes from the ability to cash flow these new purchases and for tax reasons. GPS systems have also elevated equipment costs along the way, but in most cases, this equipment has an extremely fast return on investment (ROI).
Many equipment upgrades are justified by an increase in yield and efficiency. Analyze each purchase on its own merit. For example, you might want to upgrade tractors, but a planter will give a 10% faster return.
Hidden Benefits. Seed should also be measured on its value. What was once "a bag of seed" now incorporates a tremendous amount of technology.
No one can argue that the genetics and technology in today’s seed provides us with an amazing ability to yield, even in some of the worst growing conditions. More than any other input, seed provides us with our maximum potential. The challenge is managing the environment around
the seed in order to fully capture its value.
The seed industry is also delivering value through additional services, such as agronomic assistance, crop scouting, seed treatments, informational meetings and seed delivery. These services can quickly increase returns back to the farm.
Fertilizer can constitute as much as 20% of a producer’s annual cost of production. Nitrogen, phosphorus and potassium are the primary components, and like commodity prices, can have a lot of price volatility from year to year. By keeping fertility levels balanced during the "good years," it might allow you to cut back some, especially during years when prices are high.
The other fertilizer factor to remember is our ability to manage zones. Investing appropriately within your fields, using zone management data and production potential, is the only way to
measure an absolute ROI.
While it’s important to pay attention to cost increases, it’s even more important to pay attention to value. Knowing your expenses will paint a clear picture, helping you to maximize profitability.
Chris Barron is director of operations and president of Carson and Barron Farms Inc. in Rowley, Iowa. He is also a farm business consultant and the author of the AgWeb.com blog, "Ask a Margins Expert." To submit questions and comments, e-mail Chris at email@example.com.
- November 2013