The other day, I was asked how a producer can best determine cost. The question was posed in a dairy industry setting. However, it is also appropriate for the grain and row-crop sectors, which appear to be heading for an economic reset, post the great commodity super cycle. Knowing your cost of production is essential to operating a sustainable business. Therefore, the ability to determine your cost is extremely important.
Determining cost of production requires a good foundation of financial records. First, separate business and family living expenses into two separate, cash budgets. Even if both personal and business expenses pull from the same source of revenue, it is important to calculate how much money is going to which place. Likewise, if there are separate sources of revenue, record that accordingly. These numbers will serve as your foundation for all other business evaluations.
Projected cash flow is a simple but often overlooked, tool used to determine cost. In our dairy farm and creamery businesses, we develop a cash flow on a spreadsheet with five scenarios consisting of our best estimates. Next, we use variance analysis, which is a comparison of projected cash flow to actual cash flow, to monitor business performance. We will highlight areas of deviation, both positive and negative, and provide a bulleted explanation of each variance. In some cases, it may be a macro event such as, a reduction in fuel costs, which causes the deviation. In other instances, a deviation may be caused by an internal mismanagement, like loss of a market or failure to secure a contract.
Another valuable tool is to benchmark your business performance against past years. In the grain industry, this may be a disappointment for some coming off the great commodity super cycle that took place from 2007 to 2012. Additionally, compare your business to other operations similar in size and commodities. In comparison, you may find that you are performing quite well or perhaps, have areas that can be improved. In any case, a performance record can be quite useful.
Next, focus on the larger four to five expenses for your operation. For a grain operation, those expenses may be seed, crop protectants, rent and repairs. Whereas if you are livestock oriented, larger costs may be feed and labor. This year and into 2016 may be a surprising time for some landlords as many producers will not continue to pay high cash rents. The art of negotiation will be critical in controlling cash rent costs. All assets must be evaluated in order to accurately determine productivity. Such assets may include land, machinery, equipment, and yes, even human assets must be evaluated. Shedding unproductive assets is an essential part of controlling cost.
Finally, sometimes an outside perspective or another set of eyes on the financials can be invaluable. This can be a hard tool to use as finances are sometimes viewed as private. Regardless, be careful not to allow your vanity to interfere with a successful, sustainable business.
In summary, to accurately determine your cost of production, you must have good information. Know your expenses and revenue. Efficiency requires evaluation of all assets and costs. Use available resources such as, comparison tools or financial managers, to help you determine your level of performance. Knowing your cost of production not only allows you to operate a sustainable business, it will help you improve your business to succeed in any economic environment.