Understanding the expense to produce each item or unit of goods – whether that unit is a hundredweight of milk, a flat of seedlings or a bin of apples – is an important skill for all producers. Without knowing the cost of inputs and the overhead to produce, it is difficult to know how to price your product, when to produce more of a profitable item or when to cut your losses on an unprofitable one.
Calculating your cost of production includes both variable and fixed costs. Variable costs are those costs directly related to the products you are producing, including seed, soil, water, fertilizer and labor, and are usually much easier to quantify. Fixed expenses, on the other hand, are somewhat harder to quantify on a per unit basis. These include the “DIRTI 5:” Depreciation, Interest, Repairs, Taxes and Insurance. Focusing on your variable costs can give you a distorted sense of profitability if your volume is too low to create sufficient profit to cover your fixed costs.
Fixed costs, also known as overhead, can be harder to assess when your operation turns several crops a year in the same space, such as a greenhouse. Knowing how many days a particular crop is in the greenhouse is important to determine how much that crop costs. When you’ve invested more into the crop than you can hope to recover in sales, it may be time to send that crop to the compost pile.
The same considerations are taken into account when raising animals. Over the winter months, animals don’t grow as fast. They expend much of their energy keeping themselves warm and therefore have little excess energy to put into weight gain. It’s important to understand the increased cost of caring for animals over a longer period then anticipated, so that prices can be adjusted accordingly, or you can plan differently.
Are you looking to restructure, expand or diversify your operation? Then knowing your cost of production is particularly important. While you may be taking on an expansion or upgrade project to improve energy efficiency or generate renewable energy, reduce labor costs, or to free up some of your time, financial considerations must still be taken into account. Before taking on the new project, you’ll want to understand if doubling your output will also double your profit. Or will the fixed costs of the expansion eat up all of the expected profits, leaving you in a financial position little better than when you started? Knowing and evaluating all of the facts is key to success.
Farm Credit East business consultants are experienced in measuring and evaluating a business plan for long-term success. Your team of business experts can work with you to identify the factors specific to your business that can affect cost of production. Give us a call today.