July 13, 2015
Are Fixed Farm Expenses Coming Down Yet?
By David Widmar
As production agriculture in the U.S. transitions out of the boom-era, producers face a margin squeeze resulting from declining output prices and stubbornly high input costs. In most cases, producers are facing 2015 and 2016 crop production budgets with negative returns.
We are often asked when things on the farm will improve. In an earlier post and paper, we outlined that in the long-run it is likely that a combination of three scenarios will take place to stabilize farm profitability: 1. variable costs moderate through eventual reduction in farmer demand for inputs 2. Fixed costs decline through reduction in fixed assets demands and values, and/or 3) output price may improve.
In this post, we take a look at fixed costs from the most recent data (2014) provided by the USDA and Kansas Farm Management Association (KFMA). Keep in mind that net farm incomes across the country were lower in 2014, but still well above average.
In 2014, net farm incomes were 12.9% lower than 2013 for producers in the KFMA. (Note: net farm incomes across the association peaked in 2011 with significant declines reported in 2013 and 2014). After more than two years of net income declines for association farms, it’s worth investigating the question if fixed expense, namely depreciation and family living, have come down.
In figure 1, the reported depreciation and family living expenses are shown from 2010 to 2014. Over the period, both fixed expenses increased annually. Even after national declines in net farm income in 2014 and two years of significant declines in net farm income for KFMA producers, these fixed expenses have continued higher.
Figure 1. Farm Depreciation and Family Living Expenses, 2010-2014. Data Source: Kansas Farm Management Association
While deprecation and family living have increased, it’s important to note that there has been a slow-down in the annual growth rates in recent years. Although the total expense increased in recent years, there has been some slow-down. In figure 2, the annual percentage change is reported for depreciation, family living, and machinery cost per acre. For all categories, the rates of growth were much lower than just a few years ago.
Figure 2. Annual Change in Deprecation, Family Living, and Machinery Cost (per acre), 2010-2014. Data Source: Kansas Farm Management Association.
For depreciation expenses, the KFMA data are measured and reported on an economic basis, not on a tax basis. This is important as the economic depreciable life is typically longer than the tax basis, especially when accelerated depreciation schedules are used.
The depreciation expense of a given year includes purchases made in several previous years. For example, a combine purchased this year would be a deprecation expense realized for several future years. This makes it difficult for producers to reduce their depreciation expense in a short period.
For both family living and depreciation we did not expect a significantly decrease in the expenses in just a year or two, but it is interesting these expenses have continued to increase.
The USDA estimates the cost of production for corn across the U.S. In 2011 the value of production and return (value of production less total cost) for corn production peaked and has been declining since. As in Kansas, significant declines were observed in 2013 and 2014. In 2014 alone, the value of corn production was down 19% (or $117 per acre) while the cost of production was up 2% (or $12.45 per acre.)
The USDA provided two primary expense categories: operating costs and allocated overhead. Operating expenses include categories such as seed and fertilizer and represent a variable cost of production. Allocated overhead, which includes costs such as labor, land, and general overhead, represents a fixed expense.
In figure 3, the total operating (or variable) and allocated overhead (or fixed) expenses from 2010 to 2014 are shown. While total operating costs for corn production across the U.S. has stayed rather flat since 2012, the fixed, allocated overhead costs have continued upwards. The cost of production in 2014 was up $12.45 over 2013; 89% of this increase came from an increase in allocated overhead (fixed) expenses.
Figure 3. Operating Costs (variable) and Allocated Overhead Costs (fixed) of Production for Corn in the U.S.; 2010-2014. Data Source: USDA ERS.
Although the allocated overhead (fixed expense) across the U.S. for corn production is higher in recent years, the annual percentage change in 2014 was lowest over the period, similar to results in Kansas. In 2014 the increase was 3.4% compared to 5.3% in 2013 and 7.5% in 2012.
Wrapping it Up
Grain producers are facing a financial margin squeeze. For profits to stabilize and return to a long-run “normal” a combination of lower variable costs, lower fixed costs, and/or higher commodity prices will be needed. When looking at depreciation and family living expense in Kansas, the most current data from 2014 showed that this costs had not yet come down. In fact, these expense have actually continued to increase, albeit at a slowing rate. Across the U.S., the allocated overhead expense have also been increasing as operating costs have leveled.
Another key fixed expense often considered is farmland. In an earlier post Brent looked at recent land sales data and found that prices recently have declined. Additionally, a survey of cash rents in Iowa found 2015 rates were 5.4% lower across the state.
How quickly and how significantly producers can lower their fixed expense will be important to the strength of their financial positions moving forward.
Photo by Johnny Klemme.