AgDM newsletter article, November 1996

Crop farming -- A high risk business

Don HofstrandDon Hofstrand, retired extension value added agriculture specialist, agdm@iastate.edu

Below are annual profit margins for corn on a hypothetical farm in North Iowa from 1983 through 1995. To show the inherent financial volatility of crop farming, the proceeds from risk management tools such as crop insurance proceeds, deficiency payments, disaster payments, etc., are not included in the analysis.

Figure 1. Corn profit margins

In Figure 1 the average selling price, cost per bushel, and profit per bushel are shown for the 13-year period. The actual values are shown in Table 1.

Results

There was a high level of volatility in net income with years of large profit margins and years of large loss margins.

The highest profit margin year for corn was 1995, which was caused by the high selling price and relatively low cost per bushel (due to relatively high yields). The largest loss years were 1983, 1988, and 1993 due to the high cost per bushel, which resulted from low yields (1983 and 1988 drought, and 1993 too wet). The high price in 1983 was not enough to compensate for the high cost per bushel.

From Figure 1 it appears as though the variability in cost per bushel was as great or greater than the variability in selling price. Almost all of the variability in cost per bushel was due to yield variability (the cost structure was relatively stable).

Implications

Although this represents only one situation, other farms may be similar. The variability in profit margin underscores the need to develop a risk management strategy and use risk management tools-especially due to the market focus and reduced safety net of Farm Bill (FAIR Act).

Risk management tools need to be evaluated as to how they reduce income risk rather than focusing on just selling price risk or yield risk. Price risk reduction tools like forward pricing with futures and options, and yield reduction tools like crop insurance are often more effective if they are used in combination with each other to reduce income risk.

The variability in cost per bushel from one year to the next (due to variations in yield) tends to be underestimated by most farmers. They tend to focus more closely on grain prices. However, prices may be less variable side of the profit margin equation as shown previously.

The variability in cost per bushel shows the importance of examining cost of production on a per bushel basis. Knowing your cost per bushel allows you to also know your profit (loss) margin when considering marketing decisions.

Assumptions

The average corn yield over the 13 years was 136 bu. per acre. Year to year variations in yield are based on Kanawha Research Farm data. The production costs are based on Decision File Crop Production Cost Budgets, over the last 13 years. The costs are for a cash rented farm and include a charge for operator labor and investment. The cost per bushel is computed by dividing the cost per acre by the yield. The selling price is the average cash price for the marketing year (Sept. through Aug.) following the production of each crop.

 

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