ON-FARM THOUGHTS: Knowing Your Cost of Production Helps Manage Risk
by John McGregor, MFGA Extension Support
When one talks about Cost of Production (COP) they normally refer to the average cost of producing one unit of a commodity (e.g. $135 per ton of hay or $1550 per calf). This value is calculated by totalling all of the costs associated with a farm enterprise and dividing that total by the output (yield) produced. This seems at first like a very simple formula. However, total cost of a farm enterprise frequently includes different cost categories that must be estimated and managed independently.
When one looks at determining COP it is typically broken down into three areas.
- Operating or Variable Costs
- Fixed Costs
- Owner/ Living Costs
Operating or Variable Costs - expenses that vary with levels of output.
Some examples include seed, fertilizer, fuel, repairs etc. These are often referred to as cash costs or out-of-pocket expenses and typically vary depending on the scale of production or management.
Fixed Costs - expenses that are incurred whether or not production occurs.
These expensed do not vary within a production period and are costs such as depreciation, taxes, land, building and interest on mid- and long-term loans. Fixed costs are important to consider when making long term decisions.
Owner/ Living Costs - the most important expense on a farm.
The idea of paying one’s self first can be tough when commodity prices are low or production falls below expectations, but having a reasonable income built into your COP provides a better understanding of what your actual costs will be and what level of production will be necessary if you are going to cover all your costs.
Determining COP can be a challenge. Because you’re projecting for the future you must estimate production, related expenses and what prices you expect for commodities.
Looking at inputs and production from previous years can be helpful toward estimating what inputs will be needed to meet production expectations. Estimating costs and market prices for your COP plan gets trickier the further out you are but the nice thing is that once it’s developed, you can make changes as more information becomes available.
Developing a COP is useful in that it helps you:
- Know what price is necessary for making marketing decisions
- Compare different cropping and/or livestock options
- Determine your fixed costs and whether they can be reduced
- Make informed decisions about equipment upgrades and repairs
- Evaluate insurance programs, farm expansion, diversification and land rentals
- Help determine prices for products sold off the farm such as hay
- Benchmark with comparable farms
- Provide an idea as to what might be available for personal use
Even if you can’t always be precise, calculating Cost of Production is helpful.
Benchmark with comparable farms
In the September edition of the MFGA e-Bulletin there was an article regarding the Canadian Cow-calf Cost of Production Network. This network was launched in 2020 with the objective to benchmark cow-calf production systems across Canada. Entering their third year, they are inviting all producers to sign-up for focus groups in January to March 2023, especially producers with herds over 500 head, and from Alberta, Saskatchewan and Ontario. Sign-up by November 30, 2022.
Going over the report from 2021 there is some information on benchmarks for cattle operations in western Canada. The below graph shows that total costs ranged from just under $1,000 to over $2,500/ cow. Benchmarking and knowing where you might fall within a range can get you thinking about what others are doing to lower their total costs and if some of those management practices can fit in your operation.
