capital costs?

[cowman]

Now I don't know if I am using the right term here or what, but I will try to be specific in what I am trying to get across?
Say you are feeding X number of cows this winter? You decide a tractor and bale processor are the way to go. You price out what you think you might need. Lets say $100,000 tractor and a $15,000 bale processor? For simplicity sake we'll say over a five year period the tractor decreases in value $30,000 and the processor $6,000, so your cost is $36,000 over five years or $7200/year? On top of that you have interest of say 5% on $115,000 or $5750 or $1150/year? For a total cost of $8350/year?
Now one way or the other that bill has to be paid? If you are feeding 100 cows then it costs you $83.50/cow/year...if 300 it costs $27.83/cow/year?
Now I believe that cost should be included in any meaningful calculation of your costs because the fact is: that is what it costs you? And this is applicable to any piece of equipment you use, such as squeezes, chutes, stock trailers?
These costs are directly tied to the profitability of the operation...whatever you want to call it!
I would suggest a cost of $83.50/cow/year is not acceptable just for "capital costs" for feeding equipment...but maybe $27 is?
Obviously you might be able to offset the "capital cost" of the tractor by using it in other enterprizes like haying or whatever? Then you would assign a number to that operation. However it is pretty hard to assign a different number to a bale processor or a squeeze?
The whole point of this post is I don't understand farmers sons contention that "capital interest" is not a yardage cost? If the interest is going to pay for a piece of equipment used in the feeding operation then it must be included as a cost?

[farmers_son]

I tried to explain my understanding of capital interest in the other thread. I see your post beat my post up so hopefully I answered your question already.

If you want to be accurate we should always only consider the after tax consequences of capital purchases anyway but you will never find government numbers that admit that income tax is a cost to a farming operation.

I will try one more time. Lets consider purchasing cows instead of a tractor that could be used for other things so there is no confusion about enterprise allocations.

A farmer is deciding how profitable it might be if he purchased 100 bred heifers for say $1000 each. $100,000. On the one hand he figures the profitability of this purchase decision as if he paid cash. Returns minus feed costs, yardage etc. On the other hand he figures the profitability of this purchase if he were to borrow the money and includes the capital interest as an expense. Obviously the bottom line is going to be different if he borrows the money and included capital interest. His return per animal is going to appear to be less.

But it is the same purchase, it is the same 100 heifers if the producer borrows the money or if cash is paid out of the producers own equity. Including the capital interest, although it is an expense, skews the return and distorts the bottom line.

How the purchase is financed does not affect the profitability of the purchase even though there may be cash flow consequences. Profit is not cash flow. It does not matter who provided the money for the heifer purchase, the banker or the farmer; there is only going to be so much return from those heifers. The only difference is who gets those a portion of those net returns, the banker through interet or the farmer through net returns.

In the other thread I tried to illustrate how return on equity is just interest on our personal contribution to the farm paid to ourselves. No one would ever dream of including net returns as a production expense but it is just as wrong to include capital interest paid to others for their liability contribution to the farm as a production expense. We are not figuring out our income tax here when we are figuring our production costs. They are different things and what is included as expenses for income tax does not necessarily get included as expenses for costing.

[Horse]

Farmer son I disagree with your argument as intrest is just as much an expence as feed .
If I [produce enough feed for say 100 cows it has a value equivalant to the market value such as if you Are willing to pay me $30,000 for that hay it had better bring as much going through the cow . And if I have cash in the bank it should bring as much in the cow herd, I do believe that is called oportunity costs and they are very real.
I knew a fellow one time that had great returns on his feeding operation but when questioned on it he costed everything out at cost so nothing but cattle made any money.

[smcgrath76]

I disagree wholeheartedly with Opportunity Cost in its pure form. Costing everything at market such as feed inputs is your opportunity cost, however, your competitive advantage for your beef enterprise may be that you can produce feed at below market price.
I appreciate that opportunity cost does make us look at our businesses in a useful way, but not when doing bottom line. Bascially if you look at a farm worth $1,000,000 the opportunity cost is that you could invest that same money somewhere else, do no labour and make a pretty good living. Not a fair way to assess a business' operations.

[FarmRanger]

Horse, interest is just as much an expense as any other, but I think what farmers_son is saying is that it is the part of the profit from the business that goes to someone other than the owner. Correct me if I’m wrong f_s. Basically the business provides what is called a return on assets. This can be split into two parts, the return to equity, and return to liabilities or what we more commonly think of as capital interest expense.

If we have a million dollars in assets, and it has a net profit of $50,000, that would be a 5% return on assets. A farmer with no debt in this case would also have a 5% return on equity. If you had mortgage interest of 30,000 to pay, then you would have a 20,000 return to your equity portion in the business.
What affects my decision of whether to buy the heifers is how much they actually return to my farm after all expenses including interest from buying them are paid. If that return is less than what I could have received by merely leaving my money in the bank (or the cost of borrowing), then perhaps the heifers should go somewhere else. There may be returns in raising the heifers, but it does matter how the profits are divided between interest and the farmer who is buying them.
Something monetary opportunity cost doesn’t address is lifestyle. If I’m enjoying my life raising heifers with a 2% return on equity, who is to say I’m wrong in doing that? You might say, even if I’m able to get 3% somewhere else, I might be happy to spend that 1% doing something I enjoy.

[cowman]

Interesting to see how others view these things. At the end of the day I guess we all agree that the total profit for the total farm is what really matters? And like fs says hopefully that will give you enough to live on and maybe a bit to play with!