Know your costs and your markets
by Sonja Heyck-Merlin
Agricultural economist Robin Reid and farm analyst LaVell Winsor, both of Kansas State, delivered a joint presentation at the 2021 Women Managing the Farm Conference on “The Cost of Production and Crop Marketing.”
Reid presented first, providing suggestions for determining the cost of production per acre for commodity crops. This practice is called enterprise budgeting. Before creating a budget it’s important to segment each enterprise on the farm independently. “For example,” she said, “irrigated and dryland corn would have two separate budgets.”
For each enterprise, the next step is to calculate projected income on a per acre basis. Reid suggested using the Actual Farm Production (AFP) metric to help forecast yields as well as utilizing previous crop insurance records. “Price, however, is the tricky part of calculating income,” she said. “It’s the million-dollar question.” Because of this, she advised looking at a few different scenarios with different prices and yields.
Once potential income is established, it’s time to start factoring in costs. Accounting for costs associated with basis supplies and services such as seed, fertilizer, herbicides and crop insurance are straightforward. “Make sure, however, you bring it down to the per acre level,” she said, “and don’t forget … to account for multiple application of a pesticide or fertilizer.”
According to Reid, accounting for the cost of machinery can be difficult. “Start by looking up custom rates per acre,” she recommended. With this baseline figure, producers can then examine their own machinery costs on a per acre basis, including labor, fuel, depreciation, etc. “Ultimately, there is not a perfect, easy way to capture your own machinery costs. Farmers have varying levels of equipment and economies of scale. The easiest place to start is to use the custom rates.”
Reid reminded producers not to forget incidental costs such as non-machinery labor, property taxes and interest on any operating loans. A land charge per acre should also be included since there is an opportunity cost – the loss of potential gain from other alternatives when one alternative is chosen – to using that land.
The final step of enterprise is to evaluate the budget and establish a break-even amount. Knowing the break-even amount is critical to making marketing decisions. This decision-making process was elaborated on by Winsor.
“The 2020 grain season was extremely challenging,” Winsor said. “Think about looking forward as you develop a plan for how to market and sell your production.”
Though Winsor emphasized the importance of creating a marketing plan for both old and new crops, the three primary factors in a marketing plan remain the same: the quantity available for sale, the timeframe in which it needs to be sold and the price.
“Cash price is what you get when you call the elevator,” she said. “It depends on the futures market minus the basis. Futures, similar to the stock market, are traded by the CME Group. The basis is calculated by your local market based on what they can sell the grain for minus the transportation costs and the elevator’s handling costs. The basis can be described as a local barometer for the demand of grain.”
Knowing the basis can increase producers’ marketing success. Typically, the time period used for calculating basis is the closest delivery month of the futures contract. For example, to sell grain in November, the December futures price minus the local cash price would be used to calculate the basis. Basis can vary among buyers, and producers should check around to see which buyer is offering the most attractive basis.
Winsor also said that producers should be aware of carry and inverted markets as they look to market their grain. In a carry market, the crop is worth less today than it is for a later delivery. The market is paying you to carry your crop.
An inverse market means the market is worth today more than it will be at a later date. An inverse is an indication that the market wants ownership of your product right now. Inverse markets can be infinite, according to Winsor.
Understanding basis and inverse/carry markets is just a piece of how much a market wants you to move your crop. Farmers also have personal considerations they must take into account, such as how the quality of the crop may be affected by storage, when they have time to move the grain and when they need cash flow. “Would you rather think proactively about when you need to have funds rather than be reactive?” Winsor queried.
One marketing technique Winsor discussed was selling old grain in increments. “Let’s say a farmer has 10,000 bushels of old crop stored in farm bins. They could sell 2,500 bushels each month over the next four months or sell 2,500 bushels each time the market increases by 10 cents. If establishing a target price, however, you’ll need to have a contingency plan if your target is not hit.”
As far as marketing an unharvested crop, she said it’s critical to understand the cost of production because “it gives you the confidence to make sales when profitable levels are available.” Forward contracting is an option for a new crop, but she suggested only forward contracting 10% to 24% of a crop. “I like to encourage people to walk before they run.”
Reid and Winsor are the creators of “Finances and the Farm,” an online class to enhance farm management skills. More information can be found at www.AgManager.info.