Looking at your expenses while the C price is so low might make you feel hopeless. But knowing your production cost can be empowering. It can help you make more informed business decisions, such as where to cut costs and whether to invest in additional resources.
Read on to learn more about different kinds of business expenses and how to determine your overall production cost.
Lee este artículo en español Cómo Determinar Los Costos de Producción de Tu Finca de Café
A view from Finca Vizcaya, Guatemala. Credit: Ana Valencia
Why You Should Know Your Production Cost
It’s understandable that you may want to avoid thinking about costs, but production cost is something that you can affect and optimize. You can use this information to decide whether to continue growing coffee as you are, or to make changes.
When prices are low, you can decide to cut costs or aim to maximize quality to push price differential above production cost. How different variables affect production cost is the basis of your coffee-growing operations.
Production cost is the foundation for understanding the farm, analyzing the impact of decisions, and evaluating the success of any strategies you choose to implement.
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Coffee trees under shade at Finca La Labor, Guatemala. Credit: Fernando Pocasangre
Types of Costs
To calculate your total production cost, you need to separate the types of expenses involved in producing coffee. These can be categorized into three general groups with some areas crossing over.
Variable costs are expenses directly related to the production of one finished product and they are only incurred when the good is produced. Examples include seasonal laborers employed to pick cherries and the transportation of coffee. These costs are based on how much coffee you actually produce. If you don’t produce coffee, you don’t incur them, which is why they are less risky to have in your cost structure.
Fixed costs are expenses you incur whether you produce goods or not, and that don’t depend on how much you produce. Examples include salaries for year-round employees, and agricultural inputs like fertilizer, subscriptions, and memberships. You have to pay them even if you don’t produce anything. These are more risky in have in your cost structure if production is volatile, since if you don’t produce enough, you may struggle to pay them.
Coffee cherries drying on patios at Mapache Coffee, El Salvador. Credit: Fernando Pocasangre
Investments are similar to fixed costs in that the cost of investment is normally incurred without the guarantee of production. Examples include farm equipment and renovating coffee plants. When we invest in our farms, we hope that future production will offset the cost of these investments and more, but there is no guarantee.
The amortization (useful life) of farm investments may be based on time or throughput (the rate at which a product is moved through a production process and is consumed by the end-user, such as how much coffee is processed in the wet mill over a certain period of time).
If based on time, investments behave like fixed costs. If based on throughput, they are considered more like variable costs.
Ripe coffee cherries at Mapache Coffee, El Salvador. Credit: Fernando Pocasangre
How Does This Translate to Cost Per Kilogram of Parchment Produced?
Because variable costs are directly tied to production, it’s easy to work out how they relate to the final cost per kilo. Let’s look at an example.
If picking costs the farmer US$0.15 per kg of cherry, and every 5 kg of cherry yields 1 kg of parchment, the picking cost per kg of parchment is US$0.15 x 5, so US$0.75 per kg of dry parchment produced.
Bags of coffee at Las Cruces dry mill, Guatemala. Credit: Ana Valencia
To establish how fixed costs translate to cost per kg of parchment, you need to consider how much production took place in the period of time that the fixed cost was used. You should work out the cost of the fixed item divided by how much coffee was produced over that time.
For example, if you paid an employee a fixed salary of US$500 per month, and you produced 2,000 kg of parchment that month, the cost per kg of that farm worker would be US$0.25 per kg. However, if the next month you only produced 1,000 kg, the cost of that farm worker would be US$0.50 per kg. This is why it’s good to calculate the cost each period but also work out an average cost based on several periods.
A producer holds organic fertilizer. Credit: Fernando Pocasangre
You should calculate the cost per kg of investments like fixed costs, dividing the cost per period by the production in that period. The difference is that you have to determine the cost per period. To do this, divide the amount of the investment by its useful life.
For instance, if a newly planted field will produce coffee for five years, we can divide the total investment by five if calculating year-long periods or by 60 if calculating month-long periods. If renovating one hectare of land costs US$300 and produces an average of 1500 kg of parchment for seven years, we divide 300 by seven to get a per-year period cost of about US$43 as a cost of planting per hectare per year. Then, to get the cost of planting per kg produced, divide the period cost by the production amount (43/1500), which gives you about US$0.03 per kg of parchment.
This spreadsheet can be used to clearly lay out your costs.
A spreadsheet of production costs. Credit: Karl Wienhold
Other Things to Consider
Units of Measurement
It doesn’t matter which units of measurement you use, as long as you are consistent. If working in Excel or another spreadsheet program, it’s good to have all relevant units in different columns. This way, you can access them quickly and without doing more calculations, which may result in errors.
Periods of Time
Evaluating your costs over longer periods will give you more representative averages and help you to forecast more accurately. You can also compare shorter periods to evaluate changes over time.
You will notice that fixed costs and investments have a greater impact on total cost when production is lower. Continually comparing your monthly total cost to historical average cost can help you understand whether you are improving in terms of volume.
Since production is seasonal, it can be helpful to compare each month to that same month in previous years. For example, months when you fertilize or make infrastructure improvement and there is no harvest will no doubt be unprofitable. Ideally, harvest months will be profitable enough to balance these months and show overall profit.
A worker picks coffee cherries at Finca El Aguila, El Salvador. Credit: Miguel Regalado
So what do you do now you understand how to determine cost of production? Evaluate your business records and, if you aren’t already, start tracking your costs accurately. Here are some more tips on working out accurate production costs and using this information to make improvements.
- Include family and household items as fixed costs.
- Compare production cost with sales price to calculate your profit margin.
- Calculate the impact of different decisions on production cost, sale price, and hypothetical profitability for each scenario.
- Calculate the profit margin you need to reach personal and family goals.
- Use your actual costs to plan a monthly budget. This should be based on saving enough money from the harvest to keep operating until the next harvest.
- Analyze hypothetical negative scenarios such as low production, late harvest, or low prices to determine how much downturn you can survive. Then plan how to save and make adjustments so you’re prepared if any of these events occur.
Workers sort coffee cherries at Finca El Aguila, El Salvador. Credit: Miguel Regalado
Analyzing expenses and determining production cost isn’t the most enjoyable part of coffee farming, but it’s necessary to understand your business and where you can make room for improvement. So, start keeping accurate records of your expenses and schedule regular times to review and calculate current production cost. In the long term, it could help you be more profitable and better prepared for unexpected events.
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Written by Karl Wienhold of Direct Origin Trading.
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