Budget Based Adjusted Cost of Production

Budget Based Adjusted Cost of Production Crop Enterprise Profitability Workgroup

Price Risk Management Using information that you have to help make better marketing decisions.

Knowledge of your Cost of Production (COP) is essential for making sound marketing decisions.

Methods of Determining COP Producer’s knowledge of their cost of production falls along some point of a continuum. A B C D E Continuum of knowledge about Cost of Production Estimates

Methods of Determining COP Point A of the continuum: The producer’s COP estimate is an approximated guess. COP is usually formulated using general production costs. Dividing total cost of production by total yield to get an expense per bushel. Cost estimates could be based on popular press, University or industry estimates.

Methods of Determining COP Point B of the continuum: The producer’s COP estimate is based on total crop expenses Total costs are allocated between crop enterprises. Cost figures are based on acres and yield as an expense per bushel. This approximation is likely better than a producer at point A, but still isn’t very accurate.

Methods of Determining COP Point C of the continuum: Producers use University and/or industry estimates of production costs. Derived from pooled data from a variety of sources. Generally, these estimates do take into account all expenses that should be considered. Allocations are based on previous research. This approximation is accurate for the pooled data but producer’s actual costs may be higher or lower.

Methods of Determining COP Point E of the continuum: Producers with advanced record keeping skills. Develop detailed budgets for each enterprise of their operation. Likely the most accurate COP estimate even though this method also has some limitations. A B C D E

Challenges with Determining Accurate COP Estimates Determining COP takes a great deal of time and effort. Record keeping Accurate information is often unavailable. Information from input suppliers can be lacking or confusing.

Challenges with DeterminingAccurate COP Estimates (cont.) Allocation of resources between enterprises is difficult. Fuel usage by crop Labor hours per crop enterprise Capital ownership and use (Depreciation, interest, repairs, taxes and insurance)

An Easier Method to Determine an Accurate COP Estimate Budget Based Adjusted Cost of Production (BBACOP)

What is a Budget Based Adjusted Cost of Production? A method of determining your COP that achieves point D on the continuum. May not be as accurate as the detailed enterprise budget illustrated by point E on the continuum. Method far exceeds point A, B or C on the continuum. A B C D E Continuum of knowledge about Cost of Production Estimates

What is a Budget Based Adjusted Cost of Production? (cont.) It is a method based on: COP research from Midwestern States data sets that show a relationship between production expenses for corn and soybeans Individual producers have higher or lower than “average” production costs

Cost Ratios of Crop Production Average Cost Ratio = 1.244

Advantages of BBACOP The COP estimate provides a “reasoned” base estimate for setting for target prices. The estimate is more accurate than most other methods. The estimate can be determined in a short amount of time.

Advantages of BBACOP (cont.) The estimate is adjusted for high- and low-cost producers. Limited financial information and production numbers are needed.

Information needed for BBACOP For a cash crop producer: Tax Schedule F from last year Total Schedule F expenses Total interest paid Depreciation claimed Wages and Benefits paid

Information needed for BBACOP For a cash crop producer (cont.): Change in accounts payable Change in prepaid expenses Acres of each crop in the rotation Yield estimate for the next year

Conclusions • BBACOP provides a more accurate way to determine COP estimates for setting target prices. • The method provides a much faster way of determining your COP.

Budget Based Adjusted Cost of Production