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Cost of Production and Break Even Price Analysis (2014/15)

The average budgeted unit Cost of Production (before interest), and Break Even Price (after interest), calculated from 2014/2015 client budgets for the major commodities is shown below:

Before interest

 

 

 

 

Ater interest

 

 

 

 

 

Both the Cost of Production (COP) and Break Even Prices (BEP) for wheat, canola and wool have increased since these figures were last calculated, due to higher costs. However both the COP and BEP for lambs have decreased, largely due to a slight increase in budgeted lamb sales resulting from better lambing percentages and survival.

The increases for wheat, canola and wool are due primarily to increases in the level and costs of inputs, as input usage has risen in line with increasing incomes. This phenomenon of costs rising to meet income, occurs as a result of management becoming complacent about costs when incomes are better.

Cost increases for the top 20% of producers ranked on COP have been minimal, with the bottom 20% of producers experiencing much higher cost increases. This indicates that many producers in this latter group are losing the battle. Some are living on depreciation and steadily eroding their equity.

The top 20% of producers continue to have both lower Variable and Fixed unit costs than the bottom 20%, due to higher productivity and better matching of Variable Costs to expected output.

The challenge to management is to achieve a Cost of Production which provides sufficient margin from expected commodity returns. The suggested target margin is at least 25% of expected returns. Therefore, if the net expected price for wheat is $200/tonne, the desired Cost of Production is $150/tonne or less. For lambs, if $80/head net is obtained, the Cost of Production needs to be $60/head or less to achieve a 25% margin on sales.

The unit Cost of Production for the top 20% of wheat and canola producers, continues to be about 70% of that for the bottom 20% of producers, while the unit Cost of Production for the top 20% of wool and lamb producers, is about 55% and 45% respectively of that for the bottom 20% of these producers.

The unitised Interest Cost of the top 20% of wheat, wool and lamb producers is lower than that of the bottom 20% of these producers. While the unitised Interest Cost of Production of the top 20% of canola producers is higher than that of the bottom 20%, their BEP is still lower due to lower operating costs.

Interest as a percentage of BEP for the top 20% of wheat, canola and wool producers is about 15%, while interest represents on average about 10% of BEP for the bottom 20% of producers. This is a reflection of the lowest COP producers borrowing to fund land acquisition, with the interest cost being diluted over greater production.

An example of the differences in Variable, Fixed and Interest Costs between the top 20% and bottom 20% of producers (ranked by costs), is illustrated in the following table:

CoP table

The budgeted costs for the top 20% of clients ranked on a cost per hectare basis are as follows:

Variable Costs         $206/ha          63% of Operating Costs
Fixed Costs              $121/ha          37% of Operating Costs

Operating Costs       $327/ha
Interest Costs            $47/ha          12% of Total Costs

Total Costs              $374/ha

It is interesting to note that average Fixed Costs for medium scale operations are now around $170/ha, or $69/acre, compared with the old rule of thumb of $125/ha or $50/acre, which only the very low cost or larger operators can now achieve.  This is a reflection of the higher costs of most services to business and the increased cost of doing business generally.

The average total costs of $374/ha of the top 20% of clients ranked on costs per hectare, is 22% lower than the overall average of $482/ha. This arises from Variable and Fixed Costs being 19% and 29% respectively lower than average, plus Interest Costs/ha being 18% lower than average. This top 20% group operates an average effective total area 26% larger than average.

Fixed Costs as a percentage of Operating Costs for the top 20% of clients is seen to be 37%, compared with 40% for the overall average and 43% for the bottom 20% of producers.

Having lower Fixed Costs as a percentage of Operating Costs, translates into a more robust and resilient business.