How much does it cost you to produce milk? Part 2: Calculating the cost of your farm
Dairy producers can use a customized spreadsheet to use their own farm’s financial data to calculate their cost of milk production.
It is essential for every dairy producer to know what it costs them to produce milk. Knowing your cost of production is a key piece of information that factors into a number of marketing and management decisions. Knowledge of this information is important for a number of reasons:
- determination of the magnitude of current profit/loss margin,
- comparison to past costs of production to spot trends and identify opportunities,
- ability to identify which specific costs are above industry standards so these costs can be potentially lowered, and
- for use in milk marketing to determine whether a specific milk price available through a milk marketing tool (e.g., futures and forward contracts, put options) is profitable for your farm business.
There are a wide variety of information sources that can offer guidance in determining today’s cost of producing milk. However, many of these sources have severe limitations because they use industry standards and not farm-specific financial data. It might be interesting to know what it costs your neighbor or dairy producers in your region to produce milk, but when it comes to making sound decisions on your farm you need to know what it costs on your farm to produce milk.
Fellow Michigan State University Extension farm management educator Dennis Stein and I have developed a simple spreadsheet that allows dairy producers and their consultants to use their farm’s specific financial data to estimate their cost of producing milk. This spreadsheet is primarily based on the financial data generated from the Schedule F used for federal income tax filing purposes. However, producers and their consultants can use data generated from the farm’s accounting system or a more thorough business analysis summary such as FINAN farm financial analysis using FINPACK® financial planning and analysis software. Inputs to the spreadsheet include cash expense information for every expense category that appears on the Schedule F. Each expense and income category may also be adjusted if the user desires to allocate less than 100 percent of a specific expense to the cost of producing milk. Other required information includes:
- crop acres,
- average number of cows milked,
- total milk sold (lbs.), and
- total gross milk sales ($).
It is also strongly advised that the following financial data be entered:
- cull cow income,
- other livestock income,
- other farm income,
- deacon calf income,
- crop sales income (e.g., corn, wheat, sugar beets), and
- total inventory changes (e.g., changes in accounts payable, accounts receivable, feed inventories, etc.).
The spreadsheet makes an adjustment to the cost of producing milk by first removing the costs associated with the farm’s production of “non-milk” commodities (i.e., cull cows, other livestock, other farm income, deacon calves, and crops). The sales value of these items is deducted from the total cash cost of milk production (i.e., assumes each “non-milk” source of income produced by the farm was sold at its breakeven cost of production which may or may not be true.). Second, the spreadsheet adjusts the cash cost of milk production for inventory changes (i.e., crops and feed, market livestock, accounts payable, accounts receivable, prepaid expenses, supply inventory). Some of these items can have a dramatic impact on the real cost of milk production. Adjustment should be made for expenses incurred during the year but not accounted for in cash expenses (increase in accounts payable) or, a use of cash to reduce accounts payable (paying off prior year’s accounts payable). Adjustments are also necessary for items used in the current year, but paid for in past years (decrease in prepaid expenses); or items paid for in the current year that will not be used until future years (increase in prepaid expenses). Also, changes in feed inventory are important to consider. If feed prices remain stable and feed inventory decreases those costs were incurred in past years and are not reflected in current cash costs. If feed inventory increases, those cash costs are incurred in the current year, but will not be used until future years. Without these adjustments this year’s cost of production will be confounded with past or future years. If actual data is not available, such as data provided by a FINAN or other detailed farm business financial analysis report, the data should be estimated as accurately as possible.
The final inputs to the spreadsheet are:
- family living expenses, and
- depreciation and/or actual principal repaid.
It is much better that actual total principal repaid be entered as compared with depreciation since actual principal repaid is a more accurate reflection of the real cost of milk production. Depreciation is usually highly inaccurate because today’s depreciation rules for income tax purposes allow levels of depreciation that are much higher than the real decline in asset value. Principal payments are a direct reflection of the actual cash needed to operate the business unless an abnormal amount of principal was repaid in the accounting period under investigation. This may happen due to either less than, or more than normal principal being repaid due to the existence of unusual business circumstances (e.g., a temporary principal repayment amnesty by creditors due to financial stress or extra principal repayment due to financial success). If such unusual conditions exist, the producer may want to consider entering a number more representative of the actual principal payments in a normal year. Consider asking for assistance from your financial advisor, extension educators, or other consultants to make sure your data best reflects your farm’s actual situation.
Once the data is entered into the spreadsheet the cost of production measures are calculated in an Output Section directly below the data entry section. Also, a comparison to Michigan Dairy Farm Business Analysis Summary income and expense data is provided. This comparison is done in both tabular and graphic form. These comparisons allow the producer to benchmark his/her farm’s financial performance as compared to other dairy farms in Michigan. All sections of the spreadsheet are supplied with clickable buttons that allow the printing of those specific sections.
If you would like a free copy of the spreadsheet, send an e-mail me at firstname.lastname@example.org. The spreadsheet is also available on each author’s website: Craig Thomas www.msu.edu/~thomasc (on the homepage click on “Economics,” on the “Economics” page click on “Milk Cost of Production”), or on Dennis Stein’s website www.msu.edu/~steind (on the homepage click on “Farm Business Financial Management,” on the “Farm Financial Management” page, click on “Milk Cost of Production”).