Break-even analysis on agribusiness
By Emilie Abraham
THE first question producers should ask themselves is whether their farming enterprise is a sustainable venture or not. This requires the consideration of the costs of production as well as the pricing of produce. Poor pricing decisions could potentially turn a business into a “white elephant”. Various factors influence the price of produce such as production costs incurred, demand, competitors and markets just to mention a few. To this end, farmers are advised to ensure the price of their produce reflects the actual costs of production and marketing.
To ensure proper business oversight, it is imperative that farmers keep accurate records of all costs involved to enable analyses of the sustainability of the business and to establish a break-even point. The main purpose of establishing a break–even price is to determine the price a product (e.g. chicken, head of cabbage) can be sold for in the market place to recoup its production costs. Break-even analysis can be performed at various levels such as in a short – run and/or long run depending on the objective of the farmer/producer. It is common knowledge that conflict of interest exists between farmers and consumers in the market space. The farmer is focused on getting the best return for his produce, whereas consumers are interested in obtaining high quality products at low prices i.e. value for money. To this end, determining the best price for the farm produce can be one of the most challenging aspects in the selling process.
In general, the average income for most farming enterprises is low, therefore farmers should ensure efficient operations if they are to deliver produce or products at affordable prices and still enjoy satisfactory returns on investment.
It is vital for a farmer to evaluate their farming business and its sustainability in the short term. At this level, the break-even price is calculated by using variable costs only (simply referred to as out of pocket costs) to determine the sustainability of the enterprise within a particular production cycle. This price represents the minimum price at which a product can be sold to recoup the total variable costs to stay in business for a particular production period.
For the farming enterprise to remain in business in the long term (for years), the break-even analysis considers all production costs to be incurred. Products must be sold at a price that ensures the recoupment of the total production costs and a return on investment that can sustain the enterprise in the long term. Thus, the total production cost divided by the quantity of output produced represents the minimum price at which the product can be sold. Moreover, to determine the break-even yield it is necessary to cover all costs at a given output level where the total production cost should be divided by the output price. It is therefore, worth noting that, if the price charged on the product is greater than the break-even price, this will result in a profit. Whereas any price charged below the break-even price can result in a loss.
In conclusion, the principal objective for any business enterprise is profit maximization. From a farming perspective, the most critical aspect that should be kept in mind when pricing produce is timing. A product attracts the most attention, excitement and interest from potential buyers when it hits the market first. Production timing is therefore crucial particularly in crop farming. In times of high demand, products command good prices and guarantee high profit margins. On the other hand, improper pricing at this peak interest period can be a grave mistake as it may result in the languishing of produce on the market and severe losses. Therefore, attaching a fair price to products is advisable. All in all, every farmer’s motive should be to contain costs in order to ensure reasonable pricing and a sustainable profit margin.
This article is compiled by Emilie Abraham, Technical Officer within Agribank’s Agri Advisory Services Division.