By Justin Frye, CPA
How many times have you looked at buying a piece of equipment or adding another input into your chemical program and decided against it because it was too expensive?
Every farmer has at some point in their lifetime, especially in recent years due to what some farmers perceive as the ever-increasing cost of crop production.
Higher production costs are simple to deal with when commodity prices are elevated like they have been in the past few years. However, when the cost of production inputs and commodity prices begin to converge, making these purchases based solely upon the numbers on the price tag can have a negative effect on your business.
Whether it’s chemicals, seed, fertilizer, or equipment, each investment into your operation should be analyzed appropriately in order to give you the best return on your investment.
Return on investment (ROI) is the ratio of money gained or lost on an investment relative to the cost of the investment. This simple calculation allows users to analyze and compare investments to identify the best alternative and provide them with the largest “bang for their buck.”
To put this into perspective, one of the best examples is investing in a GPS guidance system for your equipment. Some of the better systems on the market that promise accuracy down to 4 inches or less overlap can cost over $15,000.
By looking purely at the cost of the transaction, most farmers are turned away. However, looking at the ROI of the transaction yields a different story.
Say you are operating a 24-row planter and have an average 4 percent overlap without the GPS system due to point rows and potholes. This will result in you seeding an additional 6.4 acres per quarter section, or a total of 80 additional acres on a 2,000 acre farm.
By using an average cost of $100 per acre for seed, that small overlap will cost you around $640 in additional seed per field, or $8,000 per year on 2,000 acres. If you factor in fuel, labor, chemicals, and fertilizer for the remainder of the year, you easily pay for the guidance system in your first year of operation.
Equipment is a great example, but the same type of analysis can be used when purchasing your typical crop inputs. With so many different varieties of fertilizer, seed, and chemicals available today, it can be difficult to pick the one that will benefit your operation the most based purely upon the price tag.
An easy way to compare these options prior to purchase is to take the investment cost per acre and divide it by the current commodity price. This will give you the number of bushels per acre that are required to cover the cost of the investment.
For example, you find a deal on a fertilizer that will cost you approximately $50 per acre. With the current commodity price at $5.00 per bushel, you will need to produce an additional 10 bushels per acre in order to cover the cost of the fertilizer.
If your agronomist tells you that the area average for that input is an increase of 12 bushels per acre, then the ROI of the input is 2 bushels per acre, or 20 percent.
This simple analysis will change the way you manage your business, but becoming a more informed buyer for your operation takes practice. Next time you are looking to make a purchase, follow the suggested guidelines below to ensure you are making the most profitable decision.