Financial costs versus economic costs
July 18, 2008
How much does it cost you to raise a calf? Are present calf prices high enough for you to make a little money running cows? I suspect that if each of you reading this could send me your answer to the above two questions, there would be a wide range in costs associated with the first question and therefore a difference of opinion on the second question. Would the wide range in your costs to raise a calf be because your wild guesses don’t match, because your actual costs do vary that much, or because some of you are reporting financial costs and others are reporting economic costs? I am sure the answer is, yes.
Those without very good records are probably guessing, but that is not my concern here. What I want to try and illustrate is how much your financial costs may vary, based on your circumstances, and how this is different than your economic costs. Let me offer a definition for each of these two types of costs: financial costs are your costs that you incur this year, the checks you write, the cash you spend, the debit cards you use, the total amount that leaves your bank account; and economic costs would likely include most of those financial costs but would value all of your inputs at market prices.
For example, if you own your own land, you may have had some financial costs associated with fencing and providing salt for your cattle this summer, but that may have been about it for your summer pasture costs. However, your economic costs would include the value the market would pay you to lease the pasture to someone else. Your financial costs of running a cow on owned grass this summer may have been less than $5 per month. However, if you could rent that pasture for $20 per head per month, then your economic costs would be the $20 rental plus your $5 out of pocket costs.
Let me illustrate how much financial costs can vary by operation by presenting two polar opposites, but realistic examples. Mr. Goodfortune owns his ranch. It has been paid off for several years. He has no debt on his cattle or any equipment either. He bought a new pickup in 2006, because that was a good year, and he paid cash for it. He is a good operator, fertilizes his pastures and grows all his hay. He bought several bulls a couple of years back, and they will be good for another two years – of course he paid cash for them. He is growling a little because the price of diesel has gone from $2 to $4 per gallon and fertilizer costs are crazy, jumping from around $200 per ton to close to $1,000 in the last couple of years. His financial costs, the cash he will spend this year, to raise a calf, have increased from $250 to $300 per cow, but at the end of the year, there will be more cash in the bank than at the start of the year.
Mr. Nofortune is an equally astute cowboy. He has fine cattle and a desire to raise them and his kids on his own spread someday. But today, he only owns a little ground near the home place. He leases pasture from Mrs. Inheritedafortune at the top of the market, because it is a nice piece of ground and he doesn’t want to lose it. The last several years, hay has been plentiful and relatively cheap, at least compared to the cost of buying all new machinery which Mr. Nofortune would have to do if he were to put up his own hay. He also bought a new pickup in 2006, but of course the bank still holds the title on that for another couple of years. He, like Mr. Goodfortune, is paying for higher diesel and higher fertilizer for the pasture he is leasing. That plentiful and cheap hay ($45/ton) has disappeared to be replaced by scarce and expensive hay ($120/ton). Mr. Nofortune will have seen his financial costs increase from $450 per head to over $600 per head in the last couple of years. It will be a difficult Christmas this year in the Nofortune household and when the time comes to go settle up with the banker, the cash from the sale of calves will not cover all cash expenses and interest. There will be some principle on the loans that doesn’t get paid, and in today’s banking environment, Mr Nofortune will not be operating next year.
These may have been two extreme examples, but I am sure that both exist and everywhere in between. So, what is the financial cost of raising a calf? Somewhere between $300 and $650 per cow and not all cows raise a calf every year. Is ranching still financially profitable? Yes and no, depending upon an individuals financial situation.
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The economic cost of raising a calf may be fairly similar for both Mr. Goodfortune and Mr. Nofortune if they were from the same area. I suspect that in many areas of the country the economic cost of running a cow for a year is over $600 per year. There is likely not a positive economic return on many ranches this year. The market would be telling you to sell your cows, sell your hay, and either sell or lease your ground.
But, I know that most of you are ranchers, you are cowboys, you don’t want to be hay farmers or landlords. You want to be out there each day trying to make an honest living raising cattle. Therefore, my advice to you is to determine what you can do to cut back on your financial costs in the next couple of years.
However, be careful in cost cutting that you don’t cut costs that will end up reducing returns more than you reduced costs. There will likely be some high financial cost producers that will not survive in the industry with these higher costs. As they exit the industry, cattle prices will adjust upward to cover the costs of those producers who remain in the industry. It is a fairly predictable, however cruel, phenomenon associated with a free market economy.
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