Introduction to cost of production and its uses part 6

Part 6: Financial costs & farm records

A man and woman reviewing paperwork

Often not thought about as a cost of production, these cash-flow considerations are just as much a part of running a farm business as anything variable or fixed. Their importance to the overall success and longevity of the business means they deserve a brief mention. 

Most farm managers only think “financial” refers to borrowed loans or money that is used for operating, equipment or inventory purchases (i.e. feed or livestock) and even land. For a farm, those activities certainly can require borrowed funds. However, it also refers to money used for family living (i.e. groceries), income taxes and possibly even personal wages from the farm business. Consider how paying for these can affect your farm’s ability to reach its goals in the following example. 

As the farm manager, you decide that the business should be responsible for paying your IRS income taxes. There will be an estimated annual payment of $10,000. Your farm is 800 acres of soybeans and wheat raised on a 50/50 rotation. As illustrated in Table 2, you calculate that the income tax payment is $12.50 per acre. However, your estimated operating profit (after variable and fixed costs) on soybeans and wheat is expected to bring in an average of $13.50 per acre between the two enterprises.

Table 4: Net Return to Cover Cost

Average Operating Profit (soybeans & wheat)      + $13.50
Income Tax ($10,000 payment/ 800 acres)         - $12.50
Net return to cover debt                                 = $1.00

Cash-flow considerations are also part of running a farm business.

The table illustrates that by covering a portion of the income taxes, the farm is left with only $1.00 per acre or $800 total for other financial costs (i.e. debt). Should the farm still be expected to cover the same amount of income taxes? If the farm pays a smaller portion, how will the rest of the taxes be paid?

Farm Records, Planning, and Decision-making

Farm records are the most important part of finding the farm’s cost of production. They are the source of all knowledge related to the business and where current, past, and even future data is stored. But poor data storage and organization habits can keep critical pieces of information hidden. 

To aid producers in maintaining good records, the Farm Financial Standards Council annually publishes guidelines on how to maintain uniform and accurate farm records.  The MSU Telfarm program also provides accounting and financial analysis support to farmers across the state of Michigan. Additional tools and resources can be found at the MSU Extension Farm Management website, including the Farm Records Book for Management, bulletin E-1144.

As a beginning farmer, you will be challenged with trying to decide what direction you want to take your business. Measuring the past, current and potential success of the goals you set for your farm is a vital part of being a farm manager and decision maker. Following these guidelines will further help you understand the farm’s strengths and weaknesses and shape the farm’s business future. Spend time today finding your farm’s cost of production and how to use it for continued growth and success!

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.

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