Management decisions – Unit cost of production allows fine-tuning

UCOP is only four letters, but the impact it can have on a farming and ranching operation is tremendous.

Unit cost of production (UCOP) is the process of combining both input and production costs, while measuring and showing the benefit of inputs. In the end, it helps producers understand what they are getting back in value for what they spend.

University of Nebraska Extension Specialist Aaron Berger uses a graph of annual cow/calf costs dating back 30 years to demonstrate the increase in costs. In 1985, producers spent $300 to $400 annually per cow, but in the last 10 years, that amount has doubled, and it continues to increase, he noted.

“I like to use this information to think of ways to manage these costs and increase my profit,” Berger said.

Basically, producers can determine their UCOP with a simple formula. UCOP is equal to cost divided by units produced. It sounds simple, but a lot of numbers go into this formula, and some of those are harder than others to determine, he said.

Evaluating costs

Producers have two types of costs, Berger noted.

Direct costs are those that increase incrementally for each calf produced or cow in production. Examples are vaccines, salt, mineral and protein supplements.

The second, overhead costs, don’t change rapidly if more cows are added to the operation. Examples are labor, equipment, horses and buildings.

“If I have 300 cows and buy 100 more from the neighbor, I am probably not going to hire another person to help me take care of those cows,” Berger explained. “The equipment and labor I have will be spread over 400 cows, instead of 300.”

Profit

Profit is the amount of money between revenue and direct and overhead costs.

Production is the most important factor that influences profit. Ultimately, it is the pounds of product for sale.

In a cow/calf operation, many factors will determine profitability, including the adjusted pounds weaned per cow exposed, pregnancy rates, calving percentage, weaning rates and the calf weight at weaning, which influences the pounds of calf produced.

Berger said it is impossible to measure UCOP if producers don’t keep good records.

“We can not manage what we don’t measure,” he explained. “Basic financial and record-keeping numbers are important.”

Ranch decisions

“Every decision we make on a ranch influences our UCOP,” Berger stated. “If we buy a pickup to use to check our cows, that cost needs to be allocated to the cowherd for the expected life of that pickup.”

A tractor, feeding equipment, bull expense and vaccines are other examples of costs that should be allocated to the cow/calf enterprise.

By making these calculations, producers can evaluate if they are getting at least a dollar back for every dollar they put into an enterprise. It gets to a point, Berger said, where direct costs peak and begin to diminish returns. At that point, there is no longer increased production and no economic benefit for additional input, he noted.

Traditionally, producers evaluate if their ranch is profitable with a Schedule F and a balance sheet. But Berger doesn’t think that is enough to decide whether to make important changes to an operation. Most ranches have more than one enterprise, and it is important for producers to understand and see the different enterprises on their ranch so they can evaluate them and determine where changes need to be made.

Analyzing value

For instance, most ranches have some owned and rented land. In addition to being used for forage growth and grazing, the land may also have value for peace and quiet, scenery, hay and crops, recreation, conservation, minerals, wildlife, wind and water.

“Try and think of value beyond the grazing and forage potential,” Berger explained.

He encourages producers to analyze each enterprise using the following steps.

First, each enterprise needs to pay fair market value when moving resources between them.

Producers should next ask themselves, where is value being generated? They also need to evaluate where costs occur and which enterprise returns the greatest net dollar per unit input of forage.

Finally, Berger noted it is important to look at the long-term analysis over a three- to five-year period. Abnormal years may skew the results.

Distributing expenses

Based on this, a cow/calf operation should pay the land enterprise for the land to graze, and if there is a stocker/yearling operation, it should pay the cow/calf operation for the weaned calves.

However, producers may be challenged to determine expenses for items that are used in multiple enterprises, like a tractor. Berger said producers may have to rely on the hours on the tractor and estimate as close as they can.

Once a producer has all the figures, they should evaluate which enterprises generate the most income for value of input.

Ranchers may eliminate enterprises based on UCOP but not necessarily all the costs associated with it. In fact, it may increase the costs for the other enterprises sharing costs with it.

For instance, if a haying operation is eliminated but the tractor is kept for feeding livestock during the winter, the cow/calf operation and the stocker operation will have to absorb the hay enterprise’s share of those costs, Berger said.

Using UCOP

“There is a lot of value in knowing our UCOP,” Berger explained.

It helps producers budget, evaluate inputs and evaluate enterprises or entities by knowing the values so a producer can evaluate whether to expand an enterprise of eliminate it.

Producers can also use UCOP for marketing and risk management as price protection against market fluctuations.

UCOP can also be used as a benchmark to compare to other operations to help producers generate new ideas.

“I would caution producers who use UCOP as a benchmark to remember that just because someone else is meeting a benchmark, doesn’t mean they are doing it profitably. We may be doing it cheaper or making more per unit,” he explained.

Positive changes

Berger encouraged producers to use UCOP to make positive changes in their program.

“It is important to identify what needs to be changed, then pick one or two areas to focus on this year. Producers should choose areas where the greatest progress can be made and set some goals for where they want to be and how they plan to get there,” he said.

Berger also encourages producers to take a team approach to generate new ideas. He said a team may be made up of other successful ranchers, as well as veterinarians, bankers, accountants and Extension personnel.

“Enterprise analysis is critical to doing a UCOP,” he stated.

Gayle Smith is a correspondent for the Wyoming Livestock Roundup. Send comments on this article to roundup@wylr.net.