Know your cost of production for better decision making

When getting a clear financial picture for your operation, basic record keeping isn’t often enough. That’s why it’s essential to know how to calculate your historical cost of production. Getting there isn’t always straightforward, but you should know your variable and fixed costs with certainty. Your accounting software program and financial statements should give you most of the information you need.

Variable vs. fixed costs
Variable costs can be divided into two types - direct and indirect. On a grain farm, direct variable costs are likely to change for each crop since the cost of seed, fertilizer and crop protection products will be different for each.

Indirect variable costs change depending on the level of production, but it may be difficult to assign different amounts to different crops. Examples include fuel and utility costs. Often the cost of these per acre will be assigned to all crops equally.

Fixed costs are expenses that stay the same, regardless of your level of production. These include interest on land loans, property taxes and machinery depreciation. They include the expenses you pay, regardless of putting in a crop or calving cows. Some are easy to pin down - you know what they are. Others are open to interpretation, like the full cost of machinery ownership or a land investment cost.

For farms with multiple enterprises (like grain and livestock), it’s often necessary to allocate fixed costs between enterprises. You could allocate based on the gross margin percentage that an enterprise contributes or use a percentage of total expenses.

Determining cost of production is even more challenging if you’re projecting for the future. You must estimate production, related expenses and what prices you expect for commodities. However, costs and returns from the previous year can help make this easier.