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Know
Your Cost of Production
What is cost of production
(COP) and how is it calculated?
Cost of production can be calculated in several ways, depending on the
intended use. The basis of cost of production is normally the crop
enterprise, although other enterprise designations are possible. Cost
of production can and should be calculated on a per acre basis when you wish
to make a comparison among alternative crops. Use the gross margins
analysis to rank the alternatives, where Gross Margin = Gross Revenue (per
acre) – minus operating costs (per acre).
For marketing purposes,
however, you need to look at production costs on per unit of production
basis, i.e. bushels or hundredweight. Again, there are several
alternatives. First, the calculation can be done on a whole-farm basis.
Simply take the total cost of producing a commodity and divide by the actual
or expected yield. For planning purposes using actual production history is
recommended. The downside to this approach is that it assumes that cost of
production is equal across the farm. A second and the preferred alternative
is to calculate cost of production for each field or groups of similar
fields if your record keeping system allows for this. This is particularly
import in looking at cost of production on owned vs. leased ground. If
production costs are significantly higher on some rental property, perhaps
it’s time to renegotiate the lease.
Costs can be categorized
a number of different ways. First, there are operating costs. These
vary directly with production and include such things as seed, fertilizer,
fuel, etc. These inputs are used up during the year and are generally cash
expenses. Other inputs, such as tractors and equipment, last for several
years and these must be allocated to different enterprises in a way that
reflects their change in value (depreciation) over time. For calculating
cost of production, management depreciation that uses the expected years of
useful life rather than the tax life, is preferred. The type of record
system that you use will influence how easy or difficult it is to get this
information. These costs need to be allocated to different enterprises
based on use.
Another complicating factor
in calculating cost of productions is how to handle other sources of
revenue. For example, wheat and barley produce straw in addition to grain,
which also can be sold. To know the cost of production for grain
independent of the straw price, initially ignore the cost of harvesting
straw as well as the revenue. Next, subtract the gross margin for straw
from the total per acre costs of wheat or barley and recalculate the cost
per bushel or per hundredweight. The other potential source of revenue is
from the government farm program. Just as with straw, initially calculate
the cost per unit of production without including government program
payments. This is an important number as it tells you what the market would
need to provide in the absence of the farm program. Next, subtract the
expected or actual farm program payments from the total farm or per acre
cost of production, including the direct decoupled payment, loan deficiency
payment (LDP), and the counter cyclical payment.
Wheat production costs and
wheat bushels can be for the entire farm, one field, or a group of similar
fields. Production costs and wheat bushels can be either projected, using
historical farm data, or actual values for a given year.
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ACTION POINT
Calculate your Cost of Production