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"Cost accounting allows particular expenses, for example chemicals and manpower, to be assigned to a particular field, or fields, or broken down into categories which allow for a precise overall picture of expenditures on the farm. Budget categories can be compared by the computer and projections made for lenders...based on past experience."
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The flexibility that some growers are missing out on (and that many growers know they need) is cost accounting. Forget about debits and credits, balance sheets and income statements. Cost accounting isn’t about financials and taxes (although a good software program will be able to handle both cost accounting and financial reports). Cost accounting is designed to give you the management information you need to make better decisions. The idea behind cost accounting (for any type of business) is that you can break out the individual components of your operation that produce profits and incur expenses and analyze these figures to make changes to improve profitability. Cost accounting is about figuring out how you got your bottom line (profit or loss) and finding ways to improve it. |
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Cost accounting for farming operations takes another twist when you consider that profitability needs to be tracked by crop year. Crops may have growing seasons that overlap multiple calendar years and/or fiscal years. Expenses prepaid for a future crop year need to be assigned to the correct crop year for an accurate total of expenses. Income received a year or two down the road may need to be assigned to a prior crop year. With cost accounting then, you are looking at your income and expenses on a crop year basis. Financial decisions you may make for tax reasons shouldn't affect your cost accounting records.
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Cost accounting opens up new ways of looking at your farming operation. Since you have measurable units of production, cost accounting can give you a breakdown of income and expenses by acre and yield units. This gives you a basis for comparing performance of different fields, determining why one block may be producing more than another, analyzing optimal use of land, experimenting with cultural practices to improve yields, reduce expenses, or improve fruit quality, etc. (Footnote 1) When one of our customers was looking at our software, he told me that he knew that their operation was losing money on cotton, but they had never kept any figures on expenses and income for cotton broken out separately from their other crops. Without the hard figures, he couldn't recommend to his father that they switch to something else. (See the article "Know when to fold 'em" from The Grower) So if your profits are marginal or you’re losing money on a crop, what do you grow in its place? Again, cost accounting to the rescue! With accurate cost accounting records, you will be able to tell which of your crops is most profitable. That gives you a starting point. From your own experience you’ll have to figure in the capital and other resources (labor, time, equipment, etc.) required to switch to that crop, as well as evaluate market conditions, what crops may grow best on the land, your long term financial goals, and other factors. |
"Derek Carlson, horticulturist, Stemilt Management, Wenachee, Wash., said cost accounting was important for planting decisions. 'Growers should know their returns and production costs block-by-block, variety-by-variety,' he said."
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As an example of how enterprise accounting records can help you make management decisions, see the article "Is replanting a profitable and affordable option?" which appeared in Good Fruit Grower (March 1, 2001).
The same principle applies, of course, when you want to expand your operation. What are you going to plant? Detailed cost accounting records will tell you what has been most profitable for you in the past, give you an idea of cash flow requirements, help you project expected profits with increased planted acreage, etc.
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"To better understand the financial strengths and weaknesses of a farming operation, a grower should break down the various parts, Klonsky said. She suggested: cultural costs, including pest control, pruning and fertilizer; cash overhead, including office expenses, insurance and taxes; and non-cash overhead, including specialized equipment and land." "A bank requires a borrower to submit a monthly budget and growers who operate without loans should have the same kind of budget to better understand their expenditures, Klonsky said."
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In some cases, you might want to try something new and track the results with cost accounting. In the Central Valley, some growers are experimenting with dried on the vine raisin grapes. DOV raisins are supposed to require less labor (mechanized harvesting can be used), be less susceptible to damage from rain, produce better inspection results, and produce more per acre. (Footnote 2) In a case where a few acres or rows are converted over, a separate cost center can be set up to track the expense, yields, and income for the DOV raisins. The resulting data can then be used to decide if, when, and how fast to convert the rest of the vineyard or as a basis for developing a new vineyard. By conducting a small-acreage test of a new crop, cost accounting records can help you decide whether or not to expand it or drop it. Similar techniques have been used by growers to test new production ideas and find out what works by watching the individual profit-or-loss reports for each cost center. Successful ideas that increase profits then get used through the entire operation. |
Trying something new will normally change your cost structures. Take for example, a tree fruit grower who tries out reflective material to improve coloration and get a better price for his fruit. There will be new costs for the reflective material and the labor both to put it down and remove it. Labor costs for leaf pulling and harvesting may go down. Income is expected to go up, since you are getting a better price for the fruit. Then of course you must consider other factors that influence your bottom line. For instance, were pesticide costs higher than normal because of heavy infestations? Did you decide not to use reflective material on some blocks that had hail damage? How did market demand affect prices? Your cost accounting records give you a snapshot of each cost center for you to review and use in making decisions.
Consider another example where cost accounting may come into play: a combination dairy/farming operation with both permanent crops (almonds) and open ground. The farmer grows alfalfa which is used by the dairy operation. If there is a problem with the alfalfa though, and it is consistently costing the grower more to grow the alfalfa than he can buy it elsewhere for, cost accounting will point this out. It may be time to switch to something more profitable, maybe adding some more almonds. On the other hand, if there is a shortage of alfalfa, a reliable supply may be worth the extra cost. (Footnote 3) Remember, cost accounting is one tool that you can use to make management decisions. Your experience and knowledge and essential to interpreting and applying the information cost accounting provides you.
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Here's another example of breaking a "chain of production" in your operation down into cost centers: "... suppose you raise your own beef calves and market them after a backgrounding period. To know whether you're efficient at producing weaned calves and at backgrounding cattle, you really need to set up two profit centers. You might call the first Beef Cow/Calf and the second Cattle Backgrounding. After weaning calves you would "sell" production from the Beef Cow/Calf enterprise to the Cattle Backgrounding enterprise, at a fair market price ... This credits the Beef Cow/Calf enterprise with income, and charges the Backgrounding enterprise with expense. If you've kept a good record of other income and expenses for the two enterprises, at year's end you'll be able to determine whether both are profitable parts of the farm business."
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Suppose you invest in some new precision farming
equipment, or a new irrigation system, or you try a new pesticide. Whenever you try
something new in an effort to lower costs, increase yields or increase the quality of your
crop to get a better price, cost accounting provides you with a consistent method to
measure the success of your efforts and compare the results of one crop year to another.
With an investment in new equipment (for instance, precision farming) to increase your
yields, watching your yields and profits and comparing them to historical figures will
tell you how long (or if) your investment will take to pay off.
--"Banking on Ag", California Grower, March 1998 |
Budgets can also factor into cost accounting. By setting up budgets for each enterprise, you can then compare actual expenses to your budgets to see if you are staying on track. Budget information can produce cash flow reports to help manage your cash flow (not to mention lenders like to see these reports). Budgets can even be based on actual expenses recorded through the cost accounting system and refined from there. A good budgeting system will let you set up budgets with as much detailed information as you need for management purposes, while summarizing the budgets into easy to read cash flow reports for financial planning. |
Having all of this detailed cost accounting information may
sound wonderful, but of course
there is a flip side to it. You must have a
commitment
to recording the information you will later need to put into the computer in order to get
the reports. Typically with payroll this has been easy because time cards normally have
places to record what crop/location/cost center employees are working on. But you'll also
need to keep track of things like application of pesticides, herbicides, and fertilizer.
Record the number of acres treated and quantities used. Decide how utility bills will be
split among different cost centers. Assign expenses such as seed costs, leasing costs,
property taxes and/or crop insurance to the correct cost center. Record harvest work done
by a labor contractor accurately, expensing the bill to the appropriate cost centers.
(Footnote 4)
You may want to start small, and increase the level of detail as you progress. Or start by keeping detailed records on one or two cost centers, and later expand to others. Sometimes, reasonable estimates, past experience, or best guesses may have to substitute for exact figures. In some cases you may need to strike a balance between keeping detailed records and the time and effort required to get them.
Cost accounting can give you an edge when it comes to managing your farming operation. Accurate, detailed records give you a strong basis for improving the profitability of your operation, and help you stay on course to accomplish your goals.
Are you interested in cost accounting? Click here to take a look at The Farmer's Office 2000.
We are interested in hearing your opinions, suggestions and experiences have you had with cost accounting! Please let us know what you think about this article by sending email to datatech@DatatechAg.com.
1. The additional complexity of tracking income and expenses by cost center and crop year in addition to tracking them for tax purposes by fiscal year is the main reason most growers turn to specialized accounting software packages when they decide to implement cost accounting practices. While it's possible to track this information by hand or in a spreadsheet, the time you will save by using a program designed for farm cost accounting is worth the investment.
2. See the articles "Raisin Growers Who Laugh in the Face of Fall Rains" in the July 1998 issue of Grape Grower magazine and "Vine harvesting: A ripe idea?" from the August 24, 1997 edition of The Fresno Bee. Also see the Simpson DOV web site.
3. One of our customers faced this situation and came up with a third alternative: they got out of the dairy business and starting farming permanent crops only!
4. Regulations and situations may vary from state to state, but good labor contractors ought to be able to provide you with a detailed account of all work performed, and even break down labor by your own cost centers. Specialized payroll software systems like The Labor Contractor's Office 2000 are available for labor contractors to produce these reports.
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have a harvester which is
used on several different fields, each set up as a different cost center, you may want to
track what it costs for fuel, maintenance, repairs, etc. You can then figure the operating
costs per ton harvested, then allocate the expense of operating the harvester to each
field based on yields. This gives a more accurate profit figure for each field. If you are
planning on planting more acres in the future, this can also help you estimate harvesting
costs based on your expected yield per acre.