Introduction to cost of production and its uses part 1
Part 1: Variable costs
Every decision made on the farm involves cost. Sometimes these costs are seen immediately through dollars spent. Others are not easily visible until their impacts to production are known. Understanding what these costs of production are, how to identify them and the role they play in decision-making are important to you as a farm manager.
Having more knowledge about the farm’s operations enables producers to make more well-informed decisions. Knowledge about the farm’s cost of production is invaluable to those decisions. Within those numbers resides information about a farm’s strengths, areas of concerns or weakness and impacts to crucial activities, like land rent negotiations or when inputs are purchased. These issues can have large impacts on the current or future success of the business.
In order to apply this information, it is essential to understand each cost that goes into cost of production. This can be challenging as many concepts and measures of costs are used throughout the industry. In this series, we will clarify some of these concepts and their implications for management decision-making.
Variable Costs
These are purchases that can vary based on the farm’s production volume. Examples can include increasing fertilizer rates to obtain higher levels of yields or purchasing seed with genetics that allow the use of specific chemical products. Other examples can include purchased feed, chemicals, labor, plastic bedding, fuel, etc. These types of costs are influenced by the level of production the farm seeks to achieve and market conditions (i.e. supply and demand) in that year.
These costs are often some of the largest the farm will incur during the year. Producers will often seek to obtain a large quantity of them at one time. These “pre-paid” or “locked-in” purchases may include the entirety of the farm’s needs for a specific input. By doing this, farm managers attempt to limit their risk that the price may significantly increase for a particular item of need.
One type of input that is particularly challenging for farm managers is fertilizer. It is commonly needed in large quantities and the timing of its purchase can have a great influence on its price. For example, many retailers will offer a more favorable price for UAN (28% or 32%) nitrogen in the fall versus the spring. This is because many moderate to large farms that use this product often have on-farm storage.
Storage can provide opportunities to secure needed inputs at favorable prices and offset any concerns of availability that may exist in the spring. For farms without storage, it is important to pay attention to market trends and product availability. This allows farms to identify when the best times are to make purchases and determine how much to buy at one time. Often the best time to purchase most inputs is well in advance of when the farm intends to use them (i.e. planting time).
Labor is another variable cost that can be difficult for operations to work through. There are many factors that can influence the manager’s decision-making. These factors can include wage and benefit requirements, employee training and development, comparisons of hiring locally or pursuing migrant labor, etc. All of these can have short and long-term impacts on the future of the business.
One resource available for public use to learn about this area is MSU Extension bulletin E-2966: Labor Laws and Michigan Agriculture. As the bulletin outlines, laws and practices around farm labor are important for all farm managers to be aware of and understand.
This is part of a six-part article series from the MSU Extension Beginning Farmer DEMaND Series. The DEMaND series is a line of publications designed to help beginning farmers learn about financial and business management strategies that will assist them in developing into the next managers and decision-makers on the farm. For more information, check out the DEMaND series homepage on the MSU Extension’s Farm Management webpage.
