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A Simple Management Tool: Breakeven Analysis

Authors as Published

Gordon Groover, Extension Economist, Farm Management, Department of Agricultural and Applied Economics, Virginia Tech  (xgrover@vt.edu)

I’m not sure when I first saw someone calculate a breakeven price or table, yet I am certain it was in one of my Agricultural Economics classes during the 1970’s. If I could find that notebook, I know there would be a very yellowed sheet of paper on budgeting with something like the following equations:

Costs = Returns

Then the equation would be expanded to reflect both dollars and units:

Cost * Units = Price * Units

I would have a note somewhere about solving for a breakeven price by dividing the costs (right hand side) by the units. So let’s consider a real simple example using a corn budget with a total cost per acre of $365 ($365 * 1 acre) and an estimated yield of 100 bu. Then what’s the breakeven price? To answer this question let’s write this out in full detail:

$365 cost * 1 acre = Price $ * 100 bushels yield

So dividing the cost by the estimated yield gives the breakeven price of $3.65 per bu. This means that a field that produces 100 bushels of corn will only cover total costs when prices are above $3.65/bu.

This really simple example can be used to compare many alternatives by expanding what is included in the equation. Now to make this a bit more complicated, let’s consider a current question driven by this summer’s drought, “Should I buy hay or sell cows?” The simple breakeven analysis can be expanded to answer to this question and my answer to this question may not fit every farm in Virginia, yet it will provide a framework to consider most situations. 

Consider a farm that has a short hay crop and will need to buy hay to feed 10 cows for 180 days (to maintain the current herd size until spring) or sell the 10 cows as culls. A key question is what is the breakeven price between cull cows and buying hay? That is, how high can hay prices go before I should sell cows?

Important assumptions:

  • Average weight of the 10 cows is 1,200 lbs.
  • Hauling and marketing costs, $20/head = $200 for the 10 head.
  • Hay will be fed for 180 days (a worst-case scenario).
  • Assume that cows will average 26 lbs of hay per day or a total of 23.4 tons for the 10 cows for 180 days (26 lbs * 180 days * 10 cows = 46,800lbs or 23.4 tons).
  • 15% feeding and handling loss for purchased hay. A feeding and handling loss must be added to the amount consumed to obtain how much hay to purchase. To arrive at the final amount to be purchased, multiply the amount fed by 1.0 ÷ (1.0 - loss percentage). For this example the daily amount of hay to be purchased is 30.59 lbs (26 lbs * (1.0 ÷ (1.0-0.15)) or (26 lbs * 1.1765). In this example, the farmer must purchase 30.59lbs/cow/day * 180 days or 5,506 lbs.
  • For the farm to feed 10 cows, the farmer will need to purchase approximately 27.5 tons of hay (5,506 lbs/cow x 10 cows = 55,060 lbs) to cover the hay eaten and the 15% loss.
  • Total hay hauling costs $500.
  • Hay price $175 per ton.

Putting it all together into a break-even equation:

Breakeven price of cull cows in cwt’s =
{(ton of hay to be fed * (1.0 ÷ (1.0 - loss percentage) }* price of hay/ton) 
+ total hay hauling costs + total cow hauling and marketing costs} 
÷ Cwt of cows sold

Plugging in the vales for the assumptions yields:

((23.4 tons * 1.1765 *$175) + $500 + $200) ÷ 120 = $45.98 per cwt 
or $5517.65 ÷ 120 = $45.98 per cwt

How do we interpret $45.98 per cwt? In Table 1, cull cow prices are determined from an array of hay prices ($100-$225/ton) and as hay prices increase (the costs of keeping a cow) the greater value she has as a cull. Based on the assumptions listed above (hay at $175/ton), a farmer would consider culling the 10 cows if cull prices were $45.98/cwt or less. Note: The last week of July VDACS reported cull cow prices were around $51/cwt and at this price of culls the farmer should buy hay at $175/ton. However, if hay was only available for more than $225 per ton and the long-term outlook was for cull prices to soften then it might be time to sell cows; that is, as long as cull prices are below $57.45. Note: The cow price is net of hauling and marketing ($20/hd).

Table 1: Breakeven Price of Cull Cows at Varying Purchased Hay Prices $/ton

 ----------------------------------Hay $ per ton----------------------------------
$100$125$150$175$200$225
B/E $/cwt for cull
cows
$ 28.77$ 34.51$ 40.25$ 45.98$ 51.72$ 57.45

A few points to consider that go beyond this example (thanks to David Fiske and Peter Callan for comments and questions):

  • Are the cows open or bred? Investing in pregnancy testing will definitely pay off this year by reducing the total costs of carrying an open cow that will not generate any cash flow for a year.
  • Culling poorer producing cows (a very good reason for having cow records) that require more inputs than they return in calf value is a good decision regardless of weather conditions.
  • If you reach the point of selling bred cows, these cows should sell for more than cull prices.
  • This example does not look beyond the winter feeding season. Reducing herd size will make multiple-year changes (positive and/or negative) in the farm’s financial structure.
  • Consider:
  • Culling poorer cows and replacing them with genetically improved heifers may improve profitability in a few years.
  • Culling poorer cows might improve the forage quality for the remaining cows, replacement heifers, and calves.
  • Culling bred cows will reduce cash flow and maybe profitability next year. To understand the complete impact of this action will require and individualized whole farm analysis.
  • Buying hay when you have already spent funds to make hay is the “doublewhammy” of managing a drought. That is, the winter feed supply must be purchased twice. Cash flow management will be critical for the next 12 months.

In summary, this example points out a worst case situation where hay has to be fed for 180 days at an above average price. I find the take-away point to be, do not dismiss what appears to be outrageously expensive hay until you have pushed the pencil on the breakeven consequences of selling cows.

Individual farm situations vary greatly with higher hauling costs for hay and/or cows, lower feeding losses, and so on. To consider alternatives to this example, an Excel spreadsheet is available to generate an individualized breakeven table. To obtain a copy e-mail me at groover@vt.edu.

Rights


Virginia Cooperative Extension materials are available for public use, re-print, or citation without further permission, provided the use includes credit to the author and to Virginia Cooperative Extension, Virginia Tech, and Virginia State University.

Publisher

Issued in furtherance of Cooperative Extension work, Virginia Polytechnic Institute and State University, Virginia State University, and the U.S. Department of Agriculture cooperating. Alan L. Grant, Dean, College of Agriculture and Life Sciences; Edwin J. Jones, Director, Virginia Cooperative Extension, Virginia Tech, Blacksburg; Jewel E. Hairston, Administrator, 1890 Extension Program, Virginia State, Petersburg.

Date

August 11, 2010