What Actually is Cost of Production?
Many words in the industry have multiple meanings and can sometimes get people’s heads in the wrong place. Cost of production, peer groups, transition planning and business structure are a few of them — and all of which I have chosen to work in.
Wrapping up harvest and heading into heavy planning season for next year, let’s focus on cost of production.
What’s Included in Cost of Production
We evaluate it in three ways: final cost per bushel, line-item expense per bushel and percent of total cost. Why are these three areas so important? Well, if you told me your cost per bushel of corn was $3 per bushel, first, I wouldn’t believe you, and second, how can you improve that number without more specificity?
Cost of production’s sole purpose is to account for all expenses associated with growing the crop and everything the farm pays for, such as labor, equipment replacement and buying a boat. Then, and only then, can you effectively market your grain. This is your actual cost of production.
With all of that included, if you tell me your cost of production is $5.25 for 2023, I might start to believe you.
How it Impacts the Operation
Say your cost is $5.25 per bushel of corn, and you market at an average price of $5.65. Then you have accounted for all expenses, paid yourself, covered health care, the boats, replacement of equipment and made a 7.5% margin to tuck away for savings, a rainy day or the next land purchase. Knowing that true number is impactful and liberating.
It also allows you to make changes; you can’t improve what you don’t measure. Crop insurance is one of the best examples. Four percent of cost of production can often guarantee 85% of revenue. What other line-item expense can do that? It’s not seed, fertilizer or chemicals. Know each line item by the percentage and consider how to improve it.
We built a cost of production system called Farm Profit Manager, and almost every person who reaches out to me says something to the effect of:
• “I’ve been trying to build this for 20 years.”
• “I have a spreadsheet that is similar, but I haven’t been able to tie it all together.”
• “I don’t have any idea what my cost of production is. I just know at the end of the year whether I have money in the bank or not.”
Three Areas to Watch
I challenge you as we head into 2024 to determine what your cost of production is. Do you have the following three major categories dialed in to pennies per bushel?
1. Return to management
2. Equipment cost and replacement
3. Marketing for target margin versus price action
If not, dive into the waters of cost of production and reach out with questions, comments or cost of production concerns.
