Sometimes you have to spend money to make money.

cornseedIt’s not just about cost per acre–even in tight times.

The current climate of low crop commodity prices is squeezing margins. Some margins might even be negative if crop producers continue with current costs. As a result, crop producers might focus more intensely than usual on managing costs of production. As they consider strategies to reduce costs, producers often budget on cost per acre. This is an excellent start and certainly better than no budgeting at all, but focusing only on total costs per acre might cause producers to overlook important productivity tradeoffs. While it would be easy to lower total per-acre costs by simply reducing the amount of various inputs, doing so could reduce yields.

Budgeting on a cost per bushel of grain is another approach to consider. Three good reasons for budgeting on output units instead of than input units:

1. Ease of decision evaluation.
2. Recognition that per-unit fixed costs can decline with output increases.
3. Recognizing the tradeoff between productivity and cost.

Agricultural input suppliers also should consider this analysis and focus on productivity and costs per bushel in their conversations with producers. Understanding the impact of various technologies on the production system is a great start. Communicating their influence on costs per bushel and net returns per acre is even more valuable. This is particularly true in an environment of margin pressures and intensive price shopping.

Ease of evaluating decisions

The most straightforward reason for calculating costs per bushel, rather than per acre, is that the crop being produced will be priced in dollars per bushel. Having the costs and benefits in the same units ($/bu) makes comparison easy. For example, assume that corn is earning $3.50 per bushel and budgeted costs are $900 per acre. It is difficult to know whether there is a positive margin on each bushel of corn given that the units don’t align.

A common concern with this method is that production is uncertain. It is true that without yields it isn’t possible to determine costs per bushel. No budget is going to perfectly predict the future. Instead, budgeting makes use of history and trends to make predictions about the future. Budgeting is based on forecasts that are imperfect but useful. Once the growing season ends, producers can compare actual performance to the budget to assess accuracy and improve future budgets. One source crop producers can use to begin forecasting yields is their actual production history, or APH, from crop insurance programs.

The result of budgeting based on the costs per unit of input, or dollars per acre, is that spending additional money on inputs always will appear to raise costs. Thus, a producer focused on cost control might assume that reducing expenditures would lead to improved profits. This type of analysis ignores the impact of inputs on the productivity of the operation. Some inputs increase yields more than others. As a result, the higher-yielding inputs are likely to cost more as well. A grower budgeting based on cost per acre might forego the more expensive input simply because it costs more, while someone budgeting based on cost per unit of output might note that spending additional money per acre actually reduces total cost per bushel because that input yields more bushels.

Article courtesy of Michael Gunderson for Purdue University

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