Most crop farmers should see profits in 2021. Crop prices are high, and yields appear to be on trend. However, the profit picture for the 2022 crop year is more muddled.
Farmers can lock in historically good prices, but inputs are likely substantially higher. For example, fertilizer prices a year ago might have been $400 a ton for anhydrous and now are $1,200 or more.
DECISION INSIGHTS
Farmers tend to focus on net profit per acre in determining financial decisions. I think they should focus more on contribution margin per acre since it provides better guidance in making financial decisions. This is especially true for making cash rental decisions.
Contribution margin is the excess of crop revenues over variable crop expenses. Fixed expenses such as debt service,
living costs, employee salaries and most equipment depreciation costs are not included as part of crop expenses.
You don’t include those costs because if you add acres, they will likely not increase unless you hire an additional person or upgrade your equipment.
PROFIT VERSUS LOSS
Positive contribution margin will always increase overall net profit but might not eliminate a net loss per acre.
Let’s look at an example: Alice farms 5,000 acres in Iowa. Her total fixed costs are $1 million or $200 per acre. She is reviewing budgets for a half-
section of land with high cash rents. Projected crop revenues are $1,100 and variable costs are $925. After factoring in her allocated fixed costs of $200 per acre, she is showing a loss of $25 per acre. Should she turn down the offer?
No. The half section will generate a contribution margin of $175 per acre or $56,000 to offset fixed costs. If she gets rid of these acres, her fixed costs will remain at $1 million, but her per-acre allocation will now increase to $214 per acre, which means that her overall net income has dropped by $56,000.
Contribution margin is a prospective tool for financial decisions. Net profit is a reactive tool that simply lets you know if you made a profit and by how much Take advantage of this tool.
Listen to episodes of the Farm CPA Podcast with Paul Neiffer.
Paul Neiffer is a tax principal with CLA and author of the blog, The Farm CPA. He grew up on a farm in central Washington and still resides in the state.
