Content ID

103807

Know Cost of Production – or Not

Market fluctuations make estimating costs difficult.

It looks so easy! Setting price goals for marketing crops should be a piece of cake. Calculate your cost of production. Add a percentage of that cost for your profit. Put in the order to sell – either a cash bid or a futures price will suffice. When that level is hit, the price for your production is set. All you have to do is grow and harvest the crop. Or, if you are marketing last year’s crop, deliver the grain and enjoy your profit. Unfortunately, implementing this operation in my early years of farming proved to be a frustrating experience. 

I calculated my estimated cost of production. I set price goals. Fortunately for me, the price went up. It rallied enough to hit the first target. The sale was made. The market continued to rally until the cash price at the local elevator was much higher than where my price target had been. The year was 1982. I got the price I wanted early in the season. However, I missed the opportunity to cash in on a huge rally in the soybean market.

Things could have gone the exact opposite way. The price could have missed my target by a few pennies, then turned and gone back to a level lower than where it started. In that case, the sale would have been missed completely. 

Setting the price target using cost-of-production calculations risks missing the price entirely. In the worst-case scenario, the risk is failure to make the sale. In that situation, the seller ends up with a price that is comparable to the harvesttime price with the storage and interest costs subtracted. 

Reaching Price Goals

The way grain is priced makes price goals impossible to use for setting sales targets for at least two reasons. 
First, if the desired outcome is to price grain that is still growing in the field, the level of production will not be known until harvest. This means it is impossible to know how many bushels are available for setting the price until harvest is over. In many years, the best pricing opportunities are over by the time harvest begins.

A second reason estimates are notoriously inaccurate is that machinery and land costs vary considerably. Land and machinery costs depend on the factors used in making the calculations. 

My own situation illustrates this principle. Now that I am retired, the main power source on my farm is a 4440 John Deere. It was purchased in 1982 for $20,000. As of last winter, its resale value was approximately $30,000. I don’t think I should count the appreciation in value in the 20-plus years I’ve owned that machine as a profit center in my operation. If you have a similar situation, set a base price on the item and use that price every year regardless of what the item is really worth. 

In the case of land, the farm that is the center of my operation was purchased in 1976 for $700 per acre. That was the going price of land at the time. Today, it would probably bring $8,000 if I wanted to sell out. To calculate a land cost for marketing purposes, use good judgment. Set a realistic floor price you can live with when true values are somewhere outside of a realistic range.

Setting price targets is a tough job. Making them meaningful is difficult. I prefer to divide my production into segments and sell in increments throughout the year. The number of increments and the times to make sales can be adjusted to fit any farming operation. Some farmers prefer to forward-price before the crop is grown. Others like holding through the winter for a potential spring rally. Regardless of your preference, set your targets at a realistic level and base them on good technical or seasonal factors.

Business vs. Grain Marketing Decisions

Knowing cost of production can help you make business decisions, but it can hurt you in your ability to execute on marketing decisions, says Michael Rusch, sales director of the ag/commercial division for Stewart-Peterson.

“Your cost of production is a reflection of decisions you have made on the operational side of your business. The dirty truth is that the market doesn’t care what that cost-of-production number is,” Rusch says.

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