goal of a pricing strategy is to cover your production
and operating costs, and earn something above
your costs that pays you and supports your business
plans. But to do this, you first have to know
-- Jeff Moyer,
Farm Manager at The Rodale Institute®.
“Cost and Revenue Considerations
in Farm Management Decision Making”,
Fact Sheet #546, University of Maryland, College
of Agriculture and Natural Resources, Symons Hall,
College Park, MD 20742. http://www.agnr.umd.edu/MCE/
“Diagnosing Your Farm’s Financial
Health”, Fact Sheet #538, University
of Maryland, College of Agriculture and Natural
Resources, Symons Hall, College Park, MD 20742.
“Building a Sustainable Business:
A Guide to Developing a Business Plan for Farms
and Rural Businesses”, Minnesota
Institute for Sustainable Agriculture, 411 Borlaug
Hall, 1991 Upper Buford Circle, St. Paul, MN,
55108; (800) 909-6472 (MISA). http://www.misa.umn.edu/.
“Measuring and Analyzing Farm Financial
Performance” (publication and web
site), Purdue University Extension, West Lafayette,
IN, 47907; (888) 398-4636 (EXT-INFO). http://www.agecon.purdue.edu
“When pricing our animal
products— eggs, meat, sheepskins, etc.,
I have found it CRITICAL to have kept extremely
accurate records throughout the life cycle of
that animal. Our pricing of these products is
based upon cost plus enough profit to provide
us with our portion of that commodity for free
plus a small margin of profit.”
- Alison Hosford,
Two Pond Farm, West Milford, New Jersey
In order to develop a successful pricing strategy, and to
keep your operation afloat, you need to calculate your production
costs. Most farmers KNOW this, but many will tell you that
cost calculations are easy to recommend, but hard
Actually, cost calculations are easier than you might think;
they’re just hard to start. Once you define the individual
components of your production costs and plug those numbers
into a simple record-keeping system, you’ll find that
cost calculations get a lot easier. What’s more, these
calculations will give you confidence about the current state
of your operation and help you find ways to make it more solid,
efficient, and profitable.
Basic cost calculations will provide the foundation you need
- set sound prices,
- make real money (instead of just breaking even),
- grow your operation, and
- live the life you want.
When you face the challenge of calculating costs,
you create an opportunity to increase your income
and take control of your operation.
Let’s begin by defining four basic (and often misunderstood)
terms that affect cash flow in every business:
- Cost: Money you pay, directly or indirectly,
to produce a product or service. Costs include labor (your
own labor and any hired help), rent, taxes, utilities, production
inputs, equipment depreciation, etc.
- Price: Money you receive from a customer
for a product or service. Your price should include all
your costs, plus some extra money to keep (profit, or “return
- Revenue: Money you receive from all sales
of your products and/or services (also known as gross income).
Government payments also qualify as revenue. Revenue should
cover all your business costs and give you some extra money
to keep (profit, or “return to management
- Profit: Money you get to keep from all
sales of your product or services, after all your costs
are paid (also known as net income or “return to management”).
Profits allow you to buy your daily necessities, invest
back into the business, save for retirement, and take that
family vacation you have been planning.
These definitions may seem unnecessary because we all use
these terms every day. But do we use them correctly? Many
farmers get into trouble by thinking of revenues
and profits as the same thing. In reality, profits
are only a part of revenues, the part that’s
left after production costs are subtracted. If you confuse
the two, you may regularly have to choose between covering
your costs or paying yourself (an unpleasant choice).
1. KNOW YOUR
COSTS. 2. SET YOUR PRICE.
3. MAKE A PROFIT.
Your profit is determined by three factors: 1) yield, 2)
production costs, and 3) market price (which add up to become
your gross revenue). The following graph shows how yield,
costs, and revenue work together to generate a profit or loss,
depending on where your numbers land:
You probably already know that you can calculate your profit
or loss on any given product by subtracting your product costs
from your price. (Profit [or Loss] = Price – Cost) But
look at this equation again. The take-home point (one that
most farmers miss) is that your costs and your prices
have equal power to influence your revenue and profits,
either negatively or positively.
To prove this point, look at figure 2 again. Notice that
the “break even point” is NOT a fixed point. It
can move left and right or up and down, depending on adjustments
you make to your prices (revenue) and/or costs, as illustrated
In Figure 3-A, prices remain the same, but costs increase,
which work together to reduce profit. Similarly, in Figure
3-B, costs remain the same, but prices are too low, which
also reduces profits. On the other hand, in Figure 3-C, costs
remain the same, but price premiums increase revenue, which
combine to increase profits. You can achieve similar profit
increases by keeping your prices the same, but finding ways
to lower your costs.
This is simple stuff, and most farmers already know these
basic facts. However, few make the effort to use this knowledge
to their advantage. A lot of farmers think they don’t
have the time to take a close look at their costs, and many
also believe that they can’t control the prices they
get for their products. These mind-sets are a major obstacle
to the development of a good cost calculation system. Too
many farmers throw in the towel before they begin, thinking,
“If I can’t control my price, then what good does
it do me to know my costs?”
The truth is that, while there are some yield, cost, and
price factors that you can’t control, there are also
many factors that you CAN control - perhaps more than you
realize – and cost calculations are the key
to that control. Once you make the effort to identify
and calculate your costs, you will find ways to control them,
set better prices, and adjust your yields accordingly. Cost
information can help you:
- Increase Your Market Power—You
can negotiate and set prices from a position of knowledge
and control. When customers ask about your prices, you can
clearly describe the value of your product (its production
factors, costs, and intrinsic qualities) in ways that will
encourage the customer (even the wholesale buyer) to pay
the price you want.
- Build Confidence—You will know
exactly how much money you are making or losing on a product
and can adjust your prices and sales plans accordingly.
The confidence that cost information gives you will improve
every aspect of your business.
- Reduce The Hassle of Taxes and Financing—Good
cost-tracking records allow you to process taxes and apply
for loans, grants, and other funding more easily. Your chance
of being approved for loans and grants is greatly improved
when you can accurately report current and historic production
and cost figures.
- Increase Your Business Security!—Cost
tracking helps you plan a more secure future for your farm
by providing solid facts and numbers to guide your business
WHAT ARE MY COSTS?
Standard business costs include:
- inputs (seed, amendments, animals, feed, ingredients,
- equipment and depreciation,
- labor (your own labor and hired help, along with costs
for any benefits you may provide),
- fuel and transportation,
- rent and mortgages,
- interest on mortgages and loans,
- repairs, and
Many farmers are stumped by the prospect of identifying and
totaling all the items on this list, but remember:
Knowledge is power! Even if you calculate
only a few of your most basic costs, that information can
vastly improve your pricing plan and your profits. Start simple.
Identify the costs that are easiest to tabulate (like inputs
and transportation), and leave more complex costs (like labor,
depreciation, and interest) for later, when you have time
to devote to them.
To get you started, the following definitions and the worksheets
in Parts 3
will help you identify some of your own operational costs
and compile them into a form that allows you to begin to make
Some essential cost definitions include:
- Operating (or Input) Costs: All money
spent on supplies and materials needed to produce your product
or service, such as seeds, fuel, inputs and amendments,
livestock and feed, purchased ingredients to create value-added
products, packaging materials, and similar items. To calculate
input costs for a service, you must add up the number and
cost of supplies and materials that will be used as part
of the service.
- Labor Costs: All money spent to pay
yourself and your employees (if any), and to provide benefits.
Even if only you and your family work on the farm, it’s
important that you to calculate your labor costs! To
do so, multiply the number of hours required to complete
a work task by the hourly wage you pay (or would like to
pay) yourself, your family members, or employee(s).
Calculating task-hours may sound “nit-picky”
and time consuming, but chances are that you already have
good estimates of task-hours in your head! Start with those
estimates, and then, if you want to be more exact, keep
an occasional start/stop time log for your different tasks.
After just a couple entries, you’ll have a very clear
record of task-hours, and you may even begin to see a few
places where you can improve your efficiency. Later, for
more precise labor cost calculation, you can also include
the cost of any benefits you provide to yourself, your family,
or your employee(s) in the hourly wage figure.
- Overhead (or Capital) Costs: All money
spent on work-related costs other than materials and labor.
Overhead costs can be broken into two categories:
Indirect Overhead Costs:
costs that are not tied to the production of a specific
product or service, such as utilities, mortgages and
interest, rent, insurance premiums, taxes, depreciation,
office supplies, any employee benefits, certification
costs, dues and subscriptions, advertising, accounting
and attorney fees, and similar expenses.
Direct Overhead Costs: project-specific
costs, such as equipment costs, travel costs, and similar
These are the three primary cost category headings you will
find on most crop/livestock enterprise budgets (see the budget
worksheet in Part
4). All of the above costs are also defined as
either fixed or variable:
- Fixed Costs: Expenses that stay the
same each month/year, regardless of the amount you produce
or sell. Fixed costs include mortgages, taxes, insurance,
loans, and advertising, to name a few. For example, your
tractor payments remain the same whether you sell 200 or
20,000 bushels of beans.
- Variable Costs: Expenses that change
according to the amount you produce or sell. For example,
your variable cost for fuel and seed will increase when
you increase your bean acreage from 2 to 200.
Operating and labor costs are both variable, but overhead
costs can be either fixed (mortgages, equipment loans) or
variable (advertising, equipment maintenance).
So, now that we’ve defined these important cost concepts,
how can you apply them to set a good product price (including
a profit) right now? Part
3 of this fact sheet series offers guidance to
help you identify your specific costs, and Part
4 provides a budget worksheet that gives you
a place to plug-in those numbers and put them to use right