I have never completed two posts in the same day before, but I think it is important to get the formulas and equations to you as quickly as possible for the 2014 planning and budgeting season. Next week I am hoping to add a new farmer profile. I am trying to schedule Don Kracaw former owner of Winnemucca Farms, Inc, his story is amazing.
Back to the break-even analysis- To keep it simple we will assume we are only producing potatoes, and we are hoping the potato market is better this year than last year. I always use per acre revenue and costs for analysis.
Assumptions-The potato farm is all rented ground and includes 1,000 acres, the potatoes are sold for $6 per cwt, the yield was 450 cwt per acre, total fixed costs were $700 per acre ($500 per acre rent, $200 per acre farm supervision, insurance, depreciation and machinery costs), variable growing costs are $1,800 per acre.
1.Profit equation- Total sales revenue-Total variable costs-Total fixed Costs=Profit or Net Return
(450*6=$2,700)-$1,800(variable costs)-$700(fixed costs) =$200 profit or net return
2. Break-even Analysis-(Unit sales price * yield)-(Unit VC*Yield(Y))-Fixed Costs=0
We will be solving for the break-even yield or Y using simple algebra
In order to use this formula we must convert the VC to cost per cwt ($1,800/450 cwt/acre=$4 per cwt), and subtract the fixed cost per acre.
($6/cwt*(Y))-($4 VC per cwt * Yield (Y) cwt per acre)-$700 FC/ acre=0
Y=350 cwt per acre is the break-even point, if we double check this number and plug it back in, the yield of 350 cwt per acre * $6/cwt should equal $2,500.
350*$6 = $2,100-There is a difference of $400…why?
This leads us to the conclusion that in agriculture there are no truly variable costs as in manufacturing where all the variable costs are known and measured. These costs can be defined as mixed costs or semivariable costs. These costs have both a variable and fixed component. It is IMPORTANT to keep in mind the variable cost will increase or decrease based upon the yield.
Therefore, we must calculate the break-even point differently.
VC per acre+ FC per acre / sales price per cwt
$2,500/$6 = 416 cwt per acre for the break even yield.
Double checking the number 416 * $6=$2,500
3.Target Profit Analysis- Is an extension of break-even analysis that will tell us how the yield or what the total cost invested into a crop can be in order to make the desired profit. This will have to be tweaked a little bit to accommodate for the semivariable costs.
(VC+FC)+Target Profit=Total Revenue
Lets assume we to earn a net return of $500 per acre, with the same cost structure as in the previous example.
(1,800 + $700)+500=$6 per cwt sales price
$3,000 total cost / $6 per cwt sales price
Yield must by at least 500 cwt/acre to reach the desired net return.
Let’s assume we have a good idea on what the yield will be, but are selling on the open market where there is not guarantee on the price. But we want to earn at least $500per acre.
(VC+FC+Targeted Net Return)/Expected Yield
$1,800+$700+$500/400 expected yield= $7.50 per cwt sales price is needed.
My time is gone and the fun is only beginning…..more to come
Feel free to comment on what what works the best for you. Comments are always welcome.
Work Hard, Be Patient, Never Quit, Always be Honest and Have Fun!