THE ‘COST IS RIGHT’THE ‘COST IS RIGHT’BREAK-EVENBREAK-EVENENTERPRISEENTERPRISE

ANALYISIANALYISI

Section: Advanced AgribusinessSection: Advanced Agribusiness Unit:Unit: Farm Ranch Business Management Farm Ranch Business Management

THE COST IS RIGHTTHE COST IS RIGHTGame ShowGame Show

Fixed CostsFixed Costs

• Costs that will occur regardless of the level of Costs that will occur regardless of the level of production.production.

• Costs that affect the whole operation.Costs that affect the whole operation.1.1. DepreciationDepreciation2.2. InterestInterest3.3. Insurance on facilitiesInsurance on facilities4.4. TaxesTaxes

• Costs that vary according to the level of production. Costs that vary according to the level of production. • These are the main costs associated with an enterprise break-even These are the main costs associated with an enterprise break-even

projection.projection.1. Seed1. Seed2. Fertilizer2. Fertilizer3. Fuel3. Fuel1. Feed costs1. Feed costs

a. Graina. Grainb. Hayb. Hayc. Supplementc. Supplement

2. Vet 2. Vet 3. Labor3. Labor

Variable CostsVariable Costs

Know Your Costs of ProductionKnow Your Costs of Production

Past financial records.Past financial records. Local newspapers and trade magazines.Local newspapers and trade magazines. Professionals Professionals Local businesses and other producers.Local businesses and other producers. Use the Internet.Use the Internet. Use government agencies.Use government agencies. Use universities, colleges & extension.Use universities, colleges & extension.

Fixed and Variable CostsFixed and Variable Costs

Fixed costs are not directly related to the Fixed costs are not directly related to the level of production. level of production.

Variable costs change in direct relation to Variable costs change in direct relation to volume of output. volume of output.

What is a Break-even Analysis?What is a Break-even Analysis? 1. Determine the selling price of a commodity or 1. Determine the selling price of a commodity or

product by showing you what you need to sell the product by showing you what you need to sell the item for to “break even.”item for to “break even.”

2. Determine how much you can afford to pay for 2. Determine how much you can afford to pay for certain inputs whether it be fuel or the cost of a certain inputs whether it be fuel or the cost of a feeder calf.feeder calf.

3. Break-evens are figured on a “per unit basis for 3. Break-evens are figured on a “per unit basis for ease of analysis and so you can compare your cost ease of analysis and so you can compare your cost of production with other producers.of production with other producers.

4. Break-even analysis can also help a producer 4. Break-even analysis can also help a producer analyze the volume of production they should be analyze the volume of production they should be producing at by determining at what point increasing producing at by determining at what point increasing variable cost meets total income.variable cost meets total income.

What are the break-even prices at various What are the break-even prices at various yields?“yields?“

"What are break-even yields at various input "What are break-even yields at various input prices?"prices?"

Break-even - GraphicallyBreak-even - Graphically

1 P.H. Gutierrez, former Colorado State University Cooperative Extension farm/ranch management economist and associate professor; and N.L. Dalsted, Cooperative Extension farm/ranch management specialist and professor; agricultural and resource economics. 9/92. Reviewed 10/04.

Updated Friday, June 23, 2006.

Mathematical ExplanationMathematical Explanation

BE=F/ (S-V)BE=F/ (S-V) BE = break-even pointBE = break-even point F = Total Fixed CostsF = Total Fixed Costs V = Variable CostsV = Variable Costs S = Savings or additional returns per unit S = Savings or additional returns per unit

of productionof production

Example 1Example 1 A farmer wants to buy a new combine rather than A farmer wants to buy a new combine rather than

hire a custom harvester. The total fixed costs for hire a custom harvester. The total fixed costs for the desired combine are $21,270 per year. The the desired combine are $21,270 per year. The variable costs (not counting the operator's labor) variable costs (not counting the operator's labor) are $8.75 per hour. The farmer can harvest 5 acres are $8.75 per hour. The farmer can harvest 5 acres per hour. The custom harvester charges $16.00 per per hour. The custom harvester charges $16.00 per acre. How many acres must be harvested per year acre. How many acres must be harvested per year to break-even?to break-even?

Example 2Example 2 Break-even analysis can be easily Break-even analysis can be easily

extended to consider other changes. If the extended to consider other changes. If the farm operator can save two additional farm operator can save two additional bushels of wheat per acre more than the bushels of wheat per acre more than the custom harvester, what would be the custom harvester, what would be the break-even point if wheat is worth break-even point if wheat is worth $4/bushel?$4/bushel?

Example 3Example 3 A farmer raising 1,200 acres of wheat per A farmer raising 1,200 acres of wheat per

year considers purchasing a combine. year considers purchasing a combine. How much additional return (to land, How much additional return (to land, capital labor, management and risk) would capital labor, management and risk) would result? result?

Feeder Calf Break-evenFeeder Calf Break-even

Break-even Yield = Total Costs divided by Break-even Yield = Total Costs divided by Total Production: ie. Yield, lbs, bushels, Total Production: ie. Yield, lbs, bushels, acres.acres.

Break-even Sale Price = Total Costs Break-even Sale Price = Total Costs divided by Sale Price: ie. futures price, divided by Sale Price: ie. futures price, forward contract, last year’s price.forward contract, last year’s price.

SummarySummary Determines at what level of production your costs Determines at what level of production your costs

and income are equal.and income are equal. It shows the relationship between costs, volume of It shows the relationship between costs, volume of

production and income.production and income. It shows the relationship between fixed costs and It shows the relationship between fixed costs and

variable costs and how they affect the break-even variable costs and how they affect the break-even point.point.

Break-even is reached when total receipts equals Break-even is reached when total receipts equals total costs.total costs.

Analyze one product at a time on a per unit Analyze one product at a time on a per unit basis.basis.

Variable and fixed costs should be classified by Variable and fixed costs should be classified by each individual producer according to their each individual producer according to their operation.operation.

Don’t over-use a break-even.Don’t over-use a break-even. Develop spreadsheets.Develop spreadsheets. Use break-even analyses with partial budgeting Use break-even analyses with partial budgeting

and enterprise budgeting.and enterprise budgeting. you can determine quickly the lowest amount of you can determine quickly the lowest amount of

business activity need to prevent losses.business activity need to prevent losses.

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