Elizabeth Higgins, Extension Associate, Eastern NY Commercial Horticulture Program
Every farmer has faced a scenario where they wonder if it’s worth planting or harvesting a crop. Knowing the price you need to receive or the volume you need to sell at a given price (or some combination of the two) can be helpful in determining whether or not an enterprise is likely to be profitable. A cost/volume/price analysis is the method that you can use to do this calculation.
To start you first must know the following:
Your variable costs of production. These are the expenses that you have that are directly related to producing the crop to the point of sale AND that change proportionately with the volume produced. For a vegetable crop those would be your seeds, plants, production labor inputs, chemical inputs, utilities directly used for producing the crop (usually fuel, maybe electricity), cardboard boxes and supplies.
The key concept to understand with variable costs is this: Your variable costs are what it will directly cost you to produce each unit that you sell. If the price you receive is below your variable cost per unit or your total revenue for that crop is below your total variable cost to produce that crop YOU ARE LOSING MONEY FOR EVERY UNIT YOU SELL! Producing and selling more will just dig you further in a hole. You cannot sell more and become profitable. Your only options are to either get higher prices or reduce your expenses.
Your fixed costs (overhead costs) of production. These are the expenses you have for producing a crop that are not directly/proportionately related to the volume you produce during the production period for a crop. They also include the overall costs of having an operating farm that are allocated among the enterprises you produce. You pay fixed expenses whether you produce and sell one carrot or 10,000 carrots. Fixed costs include the share of the rent (or land cost) attributable to the crop, share of depreciation for equipment used for this crop, insurance for the crop, share of management expense, share of labor expense for overall farm operations, share of marketing expenses, share of overhead administrative expenses, share of other overhead expenses.
The most important concept to understand with fixed costs is this: The more units you sell, the less impact your fixed costs will have on your overall profitability. If your revenue for a crop is above your variable costs of production, you can be profitable if you can sell enough units to also cover your fixed costs of production for that crop. The impact of sales volume on profitability is mostly attributable to your ability to spread your fixed costs over more units.
The price you plan to receive (the market price or your budgeted price). This is the starting price for the calculation. It should be the price that you think that you will receive, per sales unit, for the crop. It is also helpful to have a sense of the possible range of prices, from the lowest possible price to the highest possible price (these should be realistic).
The volume that you can produce and sell. You should start with the volume that you expect to produce and sell, you should have used this volume in calculating your variable costs. It is also helpful to have a sense of the likely range of volume (high yields vs low yields).
Do the best you can to calculate these items for your enterprise. Many diversified vegetable farms do not have expenses broken out by crop – so do the best you can to allocate your expenses proportionately to the crop using your best judgement and focusing your efforts on the expenses that are likely to be the most impactful to your budget.
You need this data because the Cost/Volume/Price Analysis looks at the interaction between the price, the variable cost of production, the fixed cost of production and the volume sold.
Let’s look at an example. I am growing an acre of carrots that are sold in 50# boxes. I plan to get $14 per box and I plan to sell 750 boxes from the acre. I have looked at prior year expenses and created a budget. I assume my variable expenses will be $7,566 and my fixed expenses will be $1,000. The data is in yellow in Figure 1: Cost-Volume-Price Spreadsheet.
Step 1. Calculate the Contribution Margin per Unit. The contribution margin per unit is how much revenue you have left per unit sold after you subtract your variable costs to produce that unit.
- Revenue Per Unit: total expected revenue / expected units to be sold (in this case 750).
- Variable Costs per Unit: Total variable costs / the number of units to be sold.
- Contribution Margin Per Unit = Revenue Per Unit – Variable Cost Per Unit.
In this example the Contribution Margin per Unit is $3.91. So after subtracting the variable costs, you earn $3.91 for every box of carrots.
Step 2. Calculate Breakeven Sales Volume. This is how many units (boxes of carrots) you need to sell at a set price ($14) to breakeven, given your variable and fixed costs.
- Target Operating Income: The income (profit) you want to receive. For breakeven it equals $0, but you can put in a number if you have a goal.
- Operating Income (profit) = Contribution Margin – Fixed Costs
- Breakeven: Operating Income = $0
- Breakeven Sales Volume = (fixed cost + target operating income) / contribution margin per unit
In this example, Breakeven Sales Volume = ($1000 + $0) / $3.91 = 255.62 boxes (at $14 per box). So, if you sell more than 256 boxes at $14 per box you will make a profit.
Step 3: Calculate the Breakeven Sales Price
Step 1: Calculate the Contribution margin per unit needed to reach target operating income. (fixed cost + target operating income) / number of units to be sold.
Step 2: Breakeven Sales Price: Add the number calculated above to the variable cost per unit to get the target operating income.
In this example, ($1,000 + $0) / 750 = $1.33 (the new contribution margin to break even). Breakeven sales price is therefore = $1.33 + $10.09 (the variable cost per unit) = $11.42 (if 750 boxes are sold).
The next logical question is: “What combination of price and volume will allow me to breakeven?” This is where having the formulas in a spreadsheet come in handy. I have developed a spreadsheet you can use to do these calculations for your farm. It is available https://bit.ly/cvpanalysis.
To use the spreadsheet, you will put in the Sales Volume, Expected Price, Expected Variable Cost and Expected Fixed Cost for your enterprise in the yellow cells. The advantage of using the spreadsheet is it is easy to generate the table: Breakeven Price at Different Sales Volumes. It already includes the formulas, so you don’t have to remember them.
To use the spreadsheet and create a graph, change the expected sales volume (yellow cell) and record in the table what the breakeven price is at that volume (blue cell). The line in blue on the graph shows the breakeven point at each combination of price and volume. Combinations above the line are profitable, combinations of price and volume below the line are not profitable. There are limits to the range of prices and volumes. The limits for boxes sold would be a minimum of 1 box for $8,566 which would be the price needed to breakeven if only 1 box of carrots is sold or 1150 boxes (the most I can realistically produce and sell with the fixed inputs I have budgeted for) at $7.45 per box. In order to have more boxes to sell I would need to change some fixed input (land, equipment, facilities).
A related question I have gotten in the past is “what price do I need to get to break even if my variable costs have unexpectedly increased?” An example would be if labor costs unexpectedly go up.
Here is how you answer this question. My prior breakeven price was $11.42 per box if I sold 750 boxes, and my variable costs are $7,566. But you can see in the spreadsheet that if variable costs are below $9,500, I will make a profit, at my planned price and sales volume. But once total variable costs get above $9,500, I would lose money for each box I sell (assuming I am selling 750 boxes at $14 per box). To make a profit I will need to sell more boxes at a higher price to cover my costs. You can use the spreadsheet to change the price, volume, variable cost and fixed cost information to see what price and sales volume combinations will work for your situation.
If you have questions about this spreadsheet you can reach me at emh56@cornell.edu or 518-949-3722.