How to determine what your farm's cost of production should be

Anna-Lisa Laca
Farm Journal

The cost of producing one cwt of milk varies widely throughout the U.S. The best business owners know that number down to the penny. Dean Strauss, Wisconsin farmer and managing partner of the 2,000-cow Majestic Crossing Dairy tracks the cost of production (COP) on a monthly, quarterly and annual basis.

The cost of producing one cwt of milk varies widely throughout the U.S. The best business owners know that number down to the penny.

“I work with my accountant on yearly and semi yearly cost of production records on an accrual basis,” Strauss says. “I keep track of a monthly spreadsheet myself. Knowing your cost of production helps inform decisions on a daily basis.”

Just because you know what your cost of production is, doesn’t mean you know what it should be. According to Matt Lange, a business consultant with Compeer Financial, there’s an easy method to calculate what your COP should be. USDA says the cost to produce one cwt of milk is around the $22 mark.

COP in Compeer’s 53-farm dairy benchmark ranges from $13.30 all the way to above $20 per cwt. A handful of producers will be under $15 in 2017, he says, around seven farms will be under $16 and a dozen producers will have a COP under $17.

According to Lange, dairies with a COP under $17 were the ones who showed positive earnings by the end of 2017. It’s important to note Lange is talking about COP on an accrual basis, not simply cash flow needs.

“Accrual cost of production can be difficult for farmers to figure because often they’re not putting a value on forages and things like that,” he says. While many farmers still want to be involved in the day to day work with cows on the dairy, Strauss says the office work is critical.

“You’ve really got to spend some time working on the paper side of this business nowadays,” he says.

During this time of slim margins, Strauss uses COP to help him be more profitable. One way he’s using COP is hedging milk for a profit.

“Farmers have this attitude that [milk prices] should go higher,” he says with a laugh. “What happens if it doesn’t?”

Tracking COP closely helps Strauss target areas where he can be more efficient. One area he’s paying close attention to now is heifer inventory.

“How many heifers do we really need,” he questions. “They’re worth very little right now and are a drain on cash.”

So what’s the magic number? For most farms, Lange says COP has to be in the $16.50 to $17 range “to have a shot at profitability.”

Calculating your target COP

According to Matt Lange, a dairy business consultant with Compeer Financial, there are two simple ways to calculate your target cost of production:

1. The 10-year average Class III price plus your average basis over the same period of time. For example, say the 10-year Class III price is $15.61 per cwt and your basis over that period of time was $1.50. ($15.61 + $1.50 = $17.10) So, the farm in this example needs to keep their COP below $17.10 to have positive earnings over the 10-year time frame, Lange says.

2. Use your 10-year average mailbox price. For example, if my average mailbox price over the past 10 years was $16.90, my COP needs to stay below that level, Lange says. The lowest lows of 2009 and the highest highs of 2014 are two reasons the 10-year average works well in this calculation, Lange says. “If you use a 10-year average as a cap for your cost of production, you’re going to still have years where you’re going to lose money,” he says. “You have at least a shot at making it.”

Reprinted by permission of Farm Journal Media