Break down that cost of production
Katelyn Allen, Associate Editor
March 1, 2021
Every business likely knows its cost of production, and a dairy farm is no different.
However, getting the most accurate picture of a farm’s costs can become blurry when considering the many different types of inputs a farm might expense over a year.
In the Penn State Extension webinar “From cash records to cost of production,” Michal Lunak described that determining your costs is not as simple as adding up paid bills. “A cost is the dollar value of an input that is consumed to produce a product,” he defined. It may or may not be cash.
Cash outflows paid to some outside entity are only a cost if the purchased item is used to produce a product during the same time period it was paid for, he explained. Cash outflows that are not considered a cost would be land purchases, principal debt payments, the owner’s draw, and equipment purchases. Lunak noted, though, that the opportunity cost of the owner’s time and equipment depreciation should be allocated as production costs.
The real costs So, what should you take into account when calculating cost of production? Lunak laid out cash and noncash costs to include.
Cash costs require an outlay of cash during the planning period, he said. In terms of cost of production, cash costs mostly refer to direct and indirect costs. Direct costs are those that are used with one specific enterprise of the business, such as dairy supplies or animal health products. On the other hand, indirect costs such as labor, fuel, repairs, and utilities relate to multiple enterprises.
An enterprise pertains to all of the different activities on the farm that result in a product for sale or contribute indirectly to production, Lunak said. Any activity that should be self-supporting is considered an enterprise, and separating out the cost of production for each enterprise identifies if certain enterprises are supporting themselves or not. Enterprises on a dairy might be the milking herd, crop production, and heifer raising.
Noncash costs refer to depreciation and accrual adjustments. Depreciation should be calculated for any asset that is used in more than one production period but will not last forever, he explained. Accrual adjustments will help understand the picture of how the business’ inventories differed from the beginning of the period to the end for items such as breeding livestock, accounts payable, and prepaid expenses.
Determining an accurate cost of production takes time and good records, but Lunak emphasized that monitoring this metric is vital for a farm in multiple ways:
It summarizes the financial information of each enterprise.
It determines breakeven cost per unit, which is useful to benchmark farm operations.
It displays the relative importance of different expenses in the business.
It can provide ideas about cost control.