NEWS for North Dakotans
Agriculture Communication, North Dakota State
University
7 Morrill Hall, Fargo, ND 58105-5665
January 22, 1998
Harlan Hughes, Extension Livestock Economist
NDSU Extension Service
[Part V In The Series: "This Is The Year to Do Your Homework Before You See Your Banker"]
Building a multiyear business plan that will maximize your beef cow herd's profits over the next few years will require many of you to intensify your herd management programs. Focusing on maximizing profits, rather than on maximizing production, requires that you evaluate your herd's production and economic efficiencies. That's why benchmarking is so critical.
Four previous market advisors in this series focused on production and economic benchmarks for evaluating the production and economic efficiencies of your beef cow herd. These Northern Plains benchmarks were generated from the average of all 1996 Northern Plains beef cow herds processed through North Dakota's Integrated Resource Management (IRM) herd analyzer. These IRM benchmarks were also presented for the low-cost one-third of the herds, the middle-cost third and the high-cost third. I recommend that you compare your herd's production and economic facts to these IRM benchmarks in an effort to identify your herd's economic strengths and weaknesses.
In this Market Advisor let's focus on benchmarks that summarize the profits generated by a beef cow herd. Gross income is the first of these benchmarks, one that was discussed in the second article of this series. Gross income is the sum of all income sources in the beef cow profit center, including inventory changes and sales of steer calves, heifer calves, cull cows, cull bulls and open yearling heifers. Inventory changes can be either negative or positive. Gross income per cow, then, becomes an accrual-adjusted income per cow. Asset values are locked in at the Jan. 1 values so that inventory change is due to changing cattle numbers rather than changing asset values. Asset values are changed between each year on December 32 (note that this date is not a typographical error) to reflect current market conditions. Paper profit and losses due to changing asset values are not considered in this business analysis.
Northern Plains benchmark herds averaged $313 gross income per cow in 1996, $358 for the low-cost third of herds, $256 for the high-cost third—a $102 per cow difference between the lowest and highest.
These Northern Plains benchmark herds averaged $351 total cost of production per cow, with average costs at $244 for the low-cost third herds, $456 for the high-cost herds. The high-cost 1/3 of herds had total production costs 87 percent higher than the low-costs herds. I am convinced that ranchers and beef farmers have no idea that costs of production can vary this much from one group of ranchers to another. And if large groups of ranchers have an 87 percent difference, imagine the cost of production differences between individual herds.
Yet a majority of the ranchers that I work with do not have a good estimate of their own costs of production. I find it hard to be overly optimistic about an industry—in this day and age—that does not even know its own costs of production. Beef's competition certainly knows its costs of production.
Quite often I am asked how family living should be represented in an economic analysis. The simple answer is that family living is not an economic cost of running a beef cow herd—family living is a cash flow cost. Cash flow and economics are two different accounting classifications. Please do not make the mistake of including family living in your herd's economic analysis.
My recommended bottom line for a beef cow profit center is the earned returns to unpaid family and operator labor, management and equity capital. In many cases, unpaid labor is more that one person. You may pay your kids and you do that for income tax purposes. Kids' salaries are part of the hired labor costs. The focus here is on unpaid family labor. This bottom line measure is the earned returns to the three resources that a ranch family contributes to the ranch business. If I am reading ranchers right, ranchers are asking, "What did my family's resources earn by running beef cows?" The answer to this question: earned net returns to unpaid family and operator labor, management and equity capital.
1996 will go down as the toughest year in the decade of the 1990s, the year that the Northern Plains benchmark herds had an average net return to unpaid family and operator labor, management and equity capital of a minus $37 per cow. The low-cost herds had an earned return of a positive $114 per cow and the high-cost herds had an earned net return of a minus $200 per cow. In short, the average net earned returns from the low-cost herds and high-cost herds differed by $314 per cow. The low-cost herds averaged $102 more gross income per cow and averaged $216 less costs per cow.
So, are you a low-cost or high-cost operator?
Cattlemen have a history of evaluating their beef cow herds via production ratios. I frequently hear ranchers comment on ratios such as calf weaning weights compared to mature cow weights. The implication is that this ratio is highly correlated with profits. The reality is that many of these production ratios are more correlated with gross income than with profits. Costs of production are generally ignored by these production ratios. As a result, most of the production ratios used by the beef industry are very poor proxies for profits. My question is, why don't we move beyond production ratios and go directly to profits?
In my opinion, the single most important benchmark for measuring the economic performance of your beef cow herd is your unit cost of producing a hundredweight of calf—hereafter referred to as unit cost of production, or UCOP. Your UCOP can be immediately compared to the market price of calves, giving you an immediate measure of profit per hundredweight of calf produced.
Unit cost of producing a hundredweight of calf is is calculated by dividing total costs of production by the total pounds of calf produced. The value of this ratio is that any production practice that you want to talk about is measured in the denominator and the cost impact of that production practice is measured in the numerator.
The Northern Plains benchmark herds had a 1996 unit cost of production of $73 per hundredweight of calf produced. The UCOP for the low-cost third of herds was $43 while for the high-cost herds it was $84 per hundredweight of calf produced—a $41 per hundredweight difference in UCOP between high-cost and low-cost herds. The one 93 percent higher than the other.
A typical rancher has more opportunity to increase profits through reducing unit costs of production than through any of the marketing alliances that I have reviewed. Yet ranchers are spending hours of management time looking at marketing alliances, and very little management time documenting and reducing UCOP. Why is this? I do not understand.
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Source: Harlan Hughes (701) 231-7380
Editor: Barry Brissman (701) 231-7866
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