| SUBSCRIBE MARKETS WEATHER LINKS HOME |
|
Better DecisionsKnowing your operation's cost of production is vital to your profitabilityBeing able to evaluate your true costs allows you to make important enterprise mix, marketing and investment decisions. Otherwise, it's just a guessing gameby JOHN MOLENHUISChoosing what enterprises to be in is one of the fundamental decisions for a farm business. And knowing the costs involved is a critical step in determining whether to remain in or embark on any line of business.Many people look for the cost of production (COP) for this crop or that livestock enterprise. But the fact is that no single dollar figure for COP is accurate for all farms, because costs can vary so much from farm to farm. Your costs are your costs, just as your asset mix and management choices are yours, and are unique to your farm. While the COP does not exist, your COP certainly does. If there is only one enterprise on the farm, calculating production costs is relatively straightforward. The more enterprises there are on the farm, the more intimidating the task of allocating whole farm costs to each of them can appear to be. It's only too easy to throw up your hands and say it's not worth the effort. Yet, on the contrary, cost control has been shown to reap the reward of higher returns. For the dairy and beef cow farms in the Ontario Farm Management Analysis Program (OFMAP), lowering their COP did result in more profits. The high-cost group managed to edge out their low-cost counterparts in gross sales per unit (per hectolitre for dairy and per cow for beef cow) for both the dairy and beef cow farm. But the low cost group's ability to control costs more than compensated for this sales disadvantage, giving them more net income at the end of the day. The Ontario Dairy and Beef Cow Summary reports are available at the Ontario Ministry of Agriculture, Food and Rural Affair's Agricultural Business Management Web site at www.gov.on.ca/OMAFRA/english/busdev/download/ofmap.htm. U.S. studies have reached similar conclusions. Researchers in Kansas and Illinois have both concluded that 70-85 per cent of the financial success of high-profit grain farms could be attributed to controlling costs. The other 15-30 per cent was a result of their ability to increase the price they received. Concentrating on cost control gave a bigger bang for the management buck. The first step in the budgeting process is to identify your enterprises. Be sure to include all of them, even the crops that are grown to be fed to livestock. With your enterprises identified, you can use existing budget templates or develop your own. OMAFRA has enterprise budget templates for a variety of crop and livestock enterprises on the Ontario Enterprise Budget website at www.gov.on.ca/OMAFRA/english/busdev/bear2000/Budgets/oeb.htm. Sample costs are included as a guide and you then enter your own farm numbers or estimates to arrive at your cost of production. The format of an enterprise budget can vary, but it typically contains three main sections -- revenue with market prices and yields, variable costs and fixed costs. Variable costs change, depending on the level of production, and tend to be the easier costs to allocate to a specific enterprise. Costs like seed, fertilizer and pesticides are allocated to the crops, veterinary and feed expenses to the livestock enterprises. Fixed costs remain the same, regardless of the level of production. They represent the ownership cost of your investments, such as building and machinery depreciation, interest on your investment, property taxes and insurance. Fixed costs tend to be harder to allocate, since the assets are usually used by more than one enterprise. One possible allocation method for whole farm costs is to take the time spent in each enterprise, weighted by the number of acres in each crop, percentage of income or total costs. Develop a set of cost allocations that make the most sense for your operation. They can take some time to assemble and require accurate recordkeeping. They can then be used year after year, provided there are no significant changes made to the farm's enterprise mix. Knowing your costs allows you to make important enterprise mix, marketing and investment decisions. Developing budgets for all enterprises identifies the winners and losers. Obviously, in the long run, an enterprise has to cover its total costs and provide a return to management to be viable. However, if it is at least covering its variable costs, it still makes sense to continue the enterprise in the short run. This will provide the opportunity to improve the market price received or decrease costs so that the enterprise can cover its total costs. Effective marketing strategies are dependent on accurate cost calculations. Pricing targets can be set, based on your variable cost and total cost levels. Without knowing your COP, it is a guessing game whether the price you receive is enough to cover all your costs and still have enough left over to buy groceries and pay for your kid's minor hockey. It may be an educated guess, based on your experience, but it is still a guess.
Because of the investment required for some enterprises, it is simply not feasible to jump in and out as prices and costs fluctuate from year to year. Looking at three to five years of past records will give you a better understanding whether the enterprise is making money for you. Investment in an enterprise that fails to meet total costs in the long run needs to be questioned and resources redirected to more profitable ventures. Your COP is a vital farm management tool for making planning decisions. With it, you will have the best and most relevant information for decision-making on your farm.BF John Molenhuis is OMAFRA's Business Analysis and Cost of Production Program Lead, based at the OMAF Brighton Resource Centre. He can be reached by phone at (613) 475-9472 or by e-mail at john.molenhuis@omaf.gov.on.ca.
|