Take home messages

• Maximum yield is not the most useful parameter on which to base production decisions.
• Cost control is becoming more critical every year.
• Highest gross margin generates greater profit than maximum yield.
• Seek profit-focused agronomic advice.
• Identify reliable gross margins: grow crops which return reliably where possible.
• Know your cost of production (COP): grow crops which have a reliably higher price than total COP.
• The office is the most important paddock on the farm.

Fertiliser and chemical spend are increasing year on year

The last decade or so has seen an increase of around 160% on chemical and fertiliser expenditure on southern Australian cropping farms (Figure 1).

Figure 1. Average total spend on chemicals and fertiliser along with percentage change in chemical and fertiliser spend (right hand axis) by financial year (Hogan 2024).

Total farm expenditure also continues to increase apace, with rising interest rates, higher land values, leading to higher total farm debt (Figure 2) coupled with inflation, all impacting total farm expenditure adversely.

Figure 2. Australian cropping farm debt FY 2014–23 (Granwal 2024).

As a result, growers are having to stretch limited financial (working capital) resources more diligently, to maximise profit and create wealth over time. Good allocation of scarce financial resources is, more than ever, separating more successful cropping businesses from the pack financially.

The production function

A production function is the relationship between resources used (land, labour, capital, water) and the resulting output. Generally speaking, if we have a fixed amount of one resource, such as land, more output can only be generated by adding additional resources to it, such as fertiliser, labour, irrigation and so on. Unfortunately, in agriculture, this function is not necessarily a linear relationship. For example, a predetermined amount of fertiliser will not always grow a known amount of grain; nor will doubling or tripling the amount of fertiliser necessarily double or triple the yield, even if all other conditions are identical. If no fertiliser were applied at all, there is usually sufficient residual soil nutrition to generate some level of yield, as long as reasonable rainfall and sunlight are received during the growing season.

Figure 3. Yield response to fertiliser input.

The law of diminishing returns

The law of diminishing returns describes the relationship between varying levels of an input (for example, fertiliser) and the resulting output (for example, grain yield). As outlined above, output from a certain input is not linear. Typically, beyond a certain point, further units of input can actually decrease output. Figure 3 illustrates this effect when increased levels of nitrogen are applied to wheat: the first 50kg/ha of urea gives a clear and strongly positive increase in yield, from about 2.0t/ha to around 3.4t/ha (that is, increasing returns). However, as more units of urea are added, the additional grain produced from each additional unit of urea applied decreases (that is, diminishing returns). Eventually, a point is reached where additional fertiliser input has a toxic effect and leads to a decrease in yield (that is, negative returns).

What are the financial implications of this yield response? If a grower’s aim was purely to maximise yield, then in the example above, the grower would apply adequate fertiliser to achieve a 6t/ha yield from their wheat crop. However, most profit-driven growers would advise against this level of input: not only does it increase the risk of a negative gross margin if maximum yield is not achieved, but it also ties up substantial additional working capital in the wheat crop. Most fertiliser recommendations are based on 90% maximum economic yield (MEY), so check with your adviser if this is the standard they provide.

How then, do you decide on the appropriate level of inputs?

Marginal cost and marginal return

The marginal cost is the additional cost of applying one additional unit of input. To use the previous example in Table 1 below, if the fertiliser in question was urea priced at $700/t, and one ‘unit’ was 25kg/ha, the cost per unit of urea is $17.50/ha. Therefore, the marginal cost of an additional 25kg ‘unit’ of urea is $17.50.

Similarly, the marginal return is the additional income generated as a result of the addition of that last unit of input. Therefore, if we are paid a farm gate price of $330/t for wheat, each additional kg of grain earns us an extra 33 cents. Table 1 illustrates this relationship. Each 25kg ‘unit’ of urea costs $17.50 and the first ‘unit’ of urea results in an additional yield of 0.7t of wheat. At $330/t, this produces a marginal return of $231/unit. Clearly, the first unit of urea is highly profitable – you will earn $231 in gross income at an added cost of only $17.50.

Table 1: Optimal yield versus maximum yield when urea price is $700/t.

This information becomes more useful in decision-making when we consider that maximum yield does not necessarily result in maximum profit, and we reflect on risk. In the above example, the maximum yield of 6.0t/ha of wheat is achieved by applying 300kg/ha of urea. However, the maximum profit of $1,772/ha is achieved by applying only 250kg/ha of urea to produce a yield of 5.8t/ha of wheat. The additional 25kg/ha of urea to reach maximum achievable profit at 250kg/ha costs an extra $17.50/ha. Considering that this produces only a further $16.50/ha in margin, it may not be worth the added risk to achieve the resulting profit.

The take home message: rather than accept yield-focused agronomic advice, focus on the financial impacts of these decisions.

When does risk outweigh return

Table 2 below is similar to that above, however, with a urea price at $1,200/t rather than $700/t. While the production function does not change, the production economics do. We now see a maximum margin at $1,647/ha, with the last several units of urea providing relatively poor returns.

Table 2: Optimal yield versus maximum yield when urea price is $1200/t.

As the urea price changes, the most profitable yield and highest margin will also likely be impacted. Thorough analysis of the impacts (that is, time in the office) will be well-rewarded when making these decisions.

Know your cost of production

Cost of production (COP) is the total cost to produce a unit of any given commodity. It must be expressed in the same terms for which the grower is paid for that commodity, such as $/t for cereal, grain legume or oilseed, $/kg for beef or lamb, and c/litre for milk. It must include:

• all variable costs to produce a unit of commodity (divide $costs/ha by yield per hectare)
• an allocation of overhead costs to producing a unit of commodity.

How do I allocate overhead costs to an enterprise

There are three common ways to allocate overhead costs: on the basis of land, whole farm gross revenue, or whole farm gross margin. For this exercise, we will stick with the simplest method, which is percentage of land area.

COP using percentage of land area calculates the percentage of the total usable hectares devoted to each enterprise and apportions that percentage of total overhead costs to each enterprise. The total costs per hectare are then divided by the yield (t/ha) to calculate the costs per tonne to produce a certain commodity. Refer to Table 3 below for an example of wheat, canola and barley cost of production.

Table 3: Calculating cost of production.

Once I know my COP, how does it help

Knowing the COP for a commodity has several benefits to your business. It will assist you to:

• identify enterprises which consistently have a commodity price higher than your COP and so are consistently profitable
• identify enterprises with a commodity price which is consistently below COP and investigate cost savings, or changes to your enterprise mix
• use commodity price projections to enhance profitability in the medium term
• select a consistently profitable enterprise mix across the business
• gain clarity around marketing decisions (for example, it is easier to sell grain when you know the profit it will generate)
• decrease business risk.

Conclusion

Reliability of production seems to be becoming more challenging and the downside risk as costs increase is greater than ever. Therefore, it is critical to be diligent when it comes to expenditure on crop inputs and ensure you are getting maximum bang for your buck from each dollar invested.

Similarly, a focus on enterprises which will reliably return a price higher than the costs to produce that commodity can reduce risk and support profitability and wealth creation in the business. More than ever, time spent in the office analysing the numbers is likely to be some of the most valuable time spent on farm.

References

Granwal L (2024) Average debt of cropping farm businesses in Australia from financial year 2014 to 2023 (https://www.statista.com/statistics/1335907/australia-cropping-farm-business-debt/)

Hogan B (2024) Are rising input costs the biggest threat to farm profitability (https://grdc.com.au/resources-and-publications/grdc-update-papers/tab-content/grdc-update-papers/2024/02/are-rising-input-costs-the-biggest-threat-to-farm-profitability)

Farming the business, sowing for your future (https://grdc.com.au/resources-and-publications/all-publications/publications/2015/01/farming-the-business-manual)

Contact details

Tony Hudson
Hudson Facilitation Pty Ltd
0407 701 330
tony@hudsonfacilitation.com.au
hudsonfacilitation.com.au