Canada: Understanding Cost Per Acre Ensures Profitable Expansion

Last Updated: May 22 2014
Article by Dean Klippenstine

This article was originally published in The Western Producer.

Producers spend a lot of money on labour, power and machinery. Management has the most control over this category of expenses. When analyzed together, it can give producers a clear picture of the real cost per acre of their operations.

Unfortunately, many operators still wrongly believe that these costs — especially machinery, which is often the bulk — can remain the same even as they expand their operation. This leads to crashing expectations down the road.

A number of expenses can be considered together as labour, power and machinery (LPM): fuel, repairs and maintenance, depreciation, wages, custom work, machinery rental and other overhead expenses that cannot be easily allocated to a specific crop.

Producers who analyze these items as one category instead of as individual expenses are able to focus on their overall operating costs and not get lost in the details.

Investment in machinery is the key driver for machinery costs per acre, but because of depreciation, the true cost of this investment is not always straightforward. The easiest way to understand depreciation is to consider it as the amount it would cost to buy a full line of machinery, use it for three years and then sell it. The industry estimates that this cost is five to 15 percent per year. Depreciation isn't only a function of use or number of hours. It also accounts for obsolescence, either by size or technological advancement.

Producers must constantly weigh cost of investment in machinery with the ability to get the job done. Harvesting 2,500 acres with a 1965 vintage combine would keep costs low, but timeliness and the capacity to harvest the crop would make this situation impractical, if not impossible. On the other hand, the cost of owning 10 new top-of-the-line combines to harvest the same 2,500 acres would virtually eliminate any hope of profit, even with the speedy harvest.

Repairs and maintenance are also a factor in machinery expense, and there is a notion that buying new machinery will lower these costs. It would seem to be a reasonable assumption, but it's not necessarily true because an operator is more likely to fix every little item on a new machine, and newer machines typically cost more to fix in both labour and parts.

Technology can make our operations more efficient and often more profitable. However, deciding which technology to adopt and at what pace presents a constant tug-of-war between long-term investment and short-term profitability.

There is a common misconception that expansion lowers an operation's LPM costs overall because some of these are "fixed costs." However, this is not so. When it comes to LPM, there is no such thing as a fixed cost. Expenses in this category will change and likely grow as a farm expands, but how much they grow depends on management. I have seen well-managed farms at 3,000, 7,000 and 13,000 acres with LPM costs per acre of $90 and $100. I have also seen 2,500, 8,000 and 12,000 acre farms with a $130 per acre LPM. These were all good farms with similar gross margins. The real difference lies in expense management rather than acreage.

Let's say that a farm takes on another section of land in the spring. Management insists that the expansion will be no problem to handle with the machinery it already has.Then, come year-end, they bring in their records to have financial statements prepared and I see their "yeah, but" list. That's the response I get when I remind them that they said they wouldn't need new equipment to take on the expansion. Their response is "yeah, but we were a little under-combined so we decided to trade up to the bigger combine. And then the grain cart wouldn't hold two full dumps easily so we traded that off. And then the auger was our bottleneck so we bought the big one, but kept our old one as a spare just in case," and so on.

Of course, profitable expansion is always a good thing. The point here is don't think your LPM cost will decrease by taking on more land. It won't. More land means more combine, more drill, more sprayer and more of everything that is required to run the operation. Understanding and using your farm's LPM cost per acre to assist in making decisions is complex. It costs more to farm today than it did 10 years ago because of inflation, new technology and the increase in costs caused by the recent increase in overall farm profitability. We have seen an increase in the average LPM cost from $50 to $70 per acre just a few years ago to $90 to $120 per acre today.

With the pressure on farm profitability, it is more important than ever to be diligent in keeping these costs in check while ensuring the crop is seeded, sprayed and harvested on time.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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