Add up everything one activity costs in a cycle, divide that total by the price you expect, and you have how much it has to sell before it stops losing money: its break-even quantity. Divide the same total by the production you expect and you have its break-even price. The gap between the production and the break-even quantity is the margin of safety, how far sales can fall before a loss begins. In an Embrapa study of an irrigated onion crop, the break-even was 13,262 kilos against 20,000 expected, so sales could fall about a third before the loss began.
Colorado State University Extension, the university’s advisory service for farmers, describes break-even as the volume of production at a given price necessary to cover all costs.
Those three numbers go on one sheet per activity, with the price and the yield you assumed written beside them and the date on top.
Midway through the cycle, a dry spell cuts the corn’s yield estimate by a fifth, and the question at the kitchen table is whether the crop still covers what it cost. If the margin of safety on the sheet is above 20 percent, it does, at the price you expected; if it is below, it does not. Without the costs added into one total, nobody at the table can answer. That answer says whether the cycle ends in a loss; whether it is still worth spending what is left, such as the harvest and the freight, is a different question with a different sum, taken up in the next section.
What goes into the total, and why one number?
The total is everything the activity spent or will spend in the cycle: the lease, the inputs, the labor, the harvest, the freight, and the machinery’s share. Embrapa, Brazil’s federal agricultural research agency, costed an irrigated onion crop this way and defines total cost as the sum of all the activity’s outlays, without sorting fixed costs from those that move with volume.
When an accountant splits fixed costs from those that rise with volume, the break-even that comes out assumes part of the spending falls if less is produced. Once most of the money is spent and the crop is in the ground, little of it can still fall, so the whole total tells you whether the cycle ends in a loss, the number that counts for the next planting decision. Before you commit to a plan, the same division, at the production you expect, gives a first answer.
Whether to carry on with the crop after the dry spell is a different sum, because what is already spent does not come back, harvested or not. Texas A&M AgriLife Extension tells producers to treat what went into planting and growing a crop as sunk at harvest time, spent and not recoverable, so it should not sway the harvest decision, and to harvest a field only if the revenue it produces is greater than the harvest cost. The sum sets the revenue still to come against what is left to spend and would not be spent if you left the field standing, such as harvesting and freight; the machinery’s depreciation runs either way and stays out.
A cost that serves two activities, such as a tractor or the farm office, has to be divided between them before it enters either total, and the division holds up best when the rule for it is written down before anyone sees the results; writing the split rule before the numbers is the subject of a separate article. The machinery’s share is depreciation, which depends on how many years you expect each machine to last, a figure worked out in how long the machine should last.
How much of your production do you have to sell?
Divide the total by the price per unit. With the break-even calculator you get this division and the one in the next section at once. A handbook on farm cost statistics from the FAO, the United Nations food and agriculture agency, writes the result as the break-even yield, “Total costs/expected price = unit produced (minimum yield required to cover all costs)”.
The Embrapa onion study runs the same division on a real crop. Against a total cost of about 9,018.70 reais a hectare (the real is Brazil’s currency, and the currency does not change the division) and a price of 0.68 reais a kilo, the break-even comes to about 13,262 kilos a hectare, the amount that has to sell before revenue catches up with cost. In the calculator the fraction is rounded up to 13,263, because selling 13,262 would leave a sliver of the cost uncovered. The study expected 20,000 kilos a hectare, so the crop clears its break-even quantity with room to spare.
At what price does it pay for itself?
Divide the same total by the production instead of the price. The FAO handbook calls the result the break-even price to cover total costs, total costs divided by the expected yield, in currency per unit produced, and Colorado State describes it as the price necessary at a given level of production to cover all costs.
For the onion crop, 9,018.70 reais divided by 20,000 kilos gives about 0.45 reais a kilo. It is the same total as the break-even quantity, read the other way: how much to sell at the price you expect, or what price you need at the production you expect. In a cow-calf herd the unit is the weaned calf, and a peer-reviewed study of beef herds in Rio Grande do Sul, in southern Brazil, figured cost per calf as total cost divided by the number of weaned calves.
The break-even price here comes from a single total of costs. When a buyer calls with an offer, it can help to have two floors instead: one that covers only the cash spent on the crop, and one that covers every cost, land included. Another article on this site, the lowest price you can take, shows how to work out both before you answer.
How far can sales fall before the loss starts?
The answer is the margin of safety: the gap between what the activity produces and its break-even quantity, as a share of production. An Embrapa cost study of a family farm in an irrigated district of the same region defines it as how far sales can fall before a loss begins. For the onion crop, 20,000 kilos minus the break-even of 13,262, divided by 20,000, comes to about 34 percent: the quantity sold could fall about a third before the crop stops paying for itself.
Rurivia calculation from the Embrapa onion study’s break-even quantity and expected production: (20,000 − 13,262) ÷ 20,000 ≈ 34 percent.
With a thin margin, a small miss is enough for a loss: a price a little lower pushes the break-even quantity up; a yield a little under the estimate shrinks the margin instead, because it is the production, not the break-even quantity, that falls. Against the dry spell that cut a fifth of the corn, a 34 percent margin holds and a 10 percent margin does not. That is worth knowing before the money goes into the cycle, not after the harvest.
What does this number not promise?
It does not promise that the price and the yield you divided by will hold, and they are the two least certain figures on the sheet. A risk study of three dairy systems in Piracanjuba, Goiás, a state in central Brazil, found that of all the variables it moved, the two that swung the result most were the sale price and the yield. An optimistic yield lowers the break-even on paper and adds nothing to the bin, and the onion study treats the yield it used as an average.
Colorado State warns of a tendency to continue to use a break-even after the cost and income functions have changed, which is why you date the sheet and redo it every cycle. The sheet covers one activity at a time and is not the plan for the whole farm; each cost line that goes into the total is worked out in the finance articles of this library.
Where to start
An afternoon, with last cycle’s invoices on the table and one activity chosen. Do the two divisions and the margin for it before moving on to the next.
With the sheet dated and the price and yield written underneath, whoever picks it up next year, the farmer, the manager or the adviser, can see which number moved: the cost, the price or the yield. The same habit, a number written before the cycle and checked after it, runs through all of farm management, well beyond costs.