As a business owner, you sit down to do your budget before most big decisions are made.
According to your calculations, if you cover all your variable and fixed costs, it will take a return of $4.62 per bushel of corn to break even. Yet you only estimate selling price at $4.26 per bushel. So why would you grow corn next year? Maybe you just ought to sit this one out?
That might be the outcome in some industries. But not in agriculture – corn will get planted. Mike Boehlje, the business owner/farmer in the above example, using real numbers, says the difference between fixed costs and variable costs explain why he will still plant corn. Boehlje is a Purdue University Extension ag economist.
"We in ag economics like to talk pure profit – we want a return on labor, machinery, interest, opportunity cost on money – every possible fixed cost there is," he says. The truth is that the variable costs to grow that bushel of corn in 2014 will be budgeted at $3.23 per bushel. So I'm not going to shut my factory down as long as I can still cover variable costs and make some money to put toward my fixed costs, which I am stuck with whether I grow corn or not."
The ag economist explains it this way: "Agriculture is a high fixed-cost industry," he says. "So farmers tend to keep operating as long as they can cover variable costs."
When hard times hit other industries, many shut down. But even in the 1980s with low commodity prices, farmers kept operating, Boehlje says. Land and equipment won't go idle. The bottom line is that even though at prices projected for next fall and prices that could be locked in now, you may not cover all your fixed costs, but you may be able to cover variable costs and a portion of the fixed costs. That's enough incentive to keep operating.