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 your costs.”
-- 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
“Diagnosing Your Farm’s Financial
Health”, Fact Sheet #538, University
of Maryland, College of Agriculture and Natural Resources,
Symons Hall, College Park, MD 20742. http://www.agnr.umd.edu/MCE/
“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
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 to do.
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 to:
- 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 to management”).
- 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
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 below:
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 development.
WHAT ARE MY COSTS?
Standard business costs include:
- inputs (seed, amendments, animals, feed, ingredients, etc.),
- 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 and 4 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,
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
- 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,
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 away.