The last leg of the growing season for summer crops is a critical time. In a low price environment many turn to cost-cutting as a way to seek profitability. Today we’ll discuss whether cutting out that last round of inputs is the most profitable decision. We’ll also highlight and demonstrate some tools that will help you in the decision-making process.
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Everyone in agriculture has a basic understanding of the profit formula. We sell what we’ve produced, pay our bills, and whatever is left over is our profit. During periods of low prices, some producers turn to cost cutting as a way to achieve higher profits. However, it is important to evaluate that decision carefully, and to use some basic economic principles to help you come to an answer. I presented this information over video during an AgriLife strategy session last week. If you would like to view that recording check out the Texas A&M AgriLife Extension YouTube page.
Marginal Value Product
In order to decide whether to invest in an input, we will use the Marginal Value Product (MVP). I know that some worry about economics being a difficult concept, and you might be thinking about skipping this section. However, all we’re doing is putting language and simple math to ideas everyone really understands. For instance, MVP helps us evaluate whether or not another unit of some input “pays for itself”. All we will do is compare MVP of an input to the cost of the input.
The value of MVP is easy to calculate. We simply take:
MVP = (Change in Yield from Input * Price of Output)/One Unit Change in Input
If the value of MVP is greater than the cost of investing in whatever input you’re evaluating, then you would be better off investing in that input.
Cotton Irrigation Example
An easy-to-use example of MVP as a decision-making tool is deciding whether or not to add another inch of irrigation to a late-season cotton crop. In the case of that decision, we would need the estimated change in cotton lint yield from an inch of irrigation and an estimated cotton price at harvest time. For the purposes of our example, we’re going to assume a harvest time price of $0.55/lb. of lint, a $3.96 per acre cost of one inch of irrigation, and a 100 pound per acre increase in yield from that inch of irrigation. Therefore, the MVP of adding an inch of irrigation is:
MVP of Additional Inch of Irrigation = (100 lbs. Lint per Acre* $0.55/lb. Lint) / 1 Inch of Irrigation per Acre
MVP of Additional Inch of Irrigation = $55 per Acre
We know that the cost of an additional inch of irrigation per acre is $3.96, which is significantly less than $55, the MVP we just calculated. In this example, by not irrigating, say, a 100 acre field, our producer would have saved $396. However, if the producer does irrigate, their profit will be:
Profit = ($55 per Acre Revenue from Additional Inch of Irrigation*100 Acres) – ($3.96 per Acre Cost from Additional Inch of Irrigation*100 Acres)
Profit = $5,104
We can see from this example, that direct cost savings does not always net the highest profits in the end.
How to Evaluate this Decision for Yourself
It is simple to develop examples of MVP. However while reading you might have thought, “100 pounds more lint per acre is too high a return on an inch of irrigation”. You might have thought “It costs me more than $3.96 an acre to add an inch of water”. Heck, you might not grow cotton, in which case this example doesn’t help you out very much. For this purpose, Texas A&M AgriLife faculty developed a Crop Profitability Analyzer that provides a template for evaluating these decisions at the individual level. Simply click the link at amarillo.tamu.edu and the spreadsheet will automatically download to your computer. It is free, and as long as you know how to use Microsoft Excel it is very easy to use.
Figure 1. Crop Profitability Analyzer Link at amarillo.tamu.edu
Once you’ve downloaded the tool, you can evaluate multiple crops, change input prices, evaluate irrigation decisions, and determine whether or not that additional unit of irrigation returns more than it costs. I’ve included an example of the Irrigated Cotton spreadsheet below. The cells to change lint yield and irrigation amount are circled in blue. The cost of irrigation fuel is circled in green. Green values must be changed in the master section of the Profitability Analyzer since they cover all crops. By changing the values of the circled amounts, the value of Returns Above Total Specified Expenses (circled in red) changes, and provides an estimate of profits under different decisions, including the cotton example.
Figure 2. Crop Profitability Analyzer – Irrigated Cotton Spreadsheet
Keep in mind that while this tool was developed for the High Plains of Texas, the values can be changed to fit operations around the state. There is even a worksheet included to add new crops if the pre-set options don’t include something that you’re growing. If you’d like more help with these decisions, feel free to contact us using the information on the Contact page. Additionally, Texas A&M AgriLife Extension provides a program called FARMAssistance. FARMAssistance brings AgriLife faculty expertise to producers in a one-on-one decision making format, and is available statewide.
Chart Challenge
We finally have a return to chart challenge! You can find the answers on Wednesday on Twitter by following @AmarilloAgecon. Comment with your chart label guesses!
