The recent sharply higher prices have been a financial benefit for those owning cows. Being able to capitalize on increasing calf prices and to sell a weigh-up cow for more than it costs to develop or purchase has made for excellent times financially for cow-calf producers.
However, the recent increase in price has also drastically increased two hidden, non-cash costs that impact a cow-calf producers’ cost of production. These two costs, which are especially pronounced in today’s current market environment, are depreciation and the opportunity cost of interest on the market value of the cow.
Depreciation is a non-cash expense that producers will not receive an invoice for, but it is a real cost! Unless the rocket like trajectory of the cattle prices continues, which historically seems unlikely, prices will eventually moderate and decline. Even if market prices remain steady, the current price structure for cows has drastically increased cow depreciation and the opportunity cost of interest on cow value.
To put this in perspective, consider that a $4,000 bred heifer today will become a $2,000 weigh-up cow at current market prices. (If weigh-up prices decline in the future the bred heifer purchased now will be worth even less when she leaves the herd.) If that bred heifer is in production for five years before it leaves the herd, exceeding the industry average, the annual depreciation is $400, excluding any death loss. The cow that dies is fully depreciated as it has zero value when it leaves the herd. Assuming an average cow value of $3,000 over its productive life, with a 2% death loss per year, the annual cost is $60 per cow per year. Cow death loss, plus depreciation, totals $460 per year for each of the five years that the cow is expected to be in production.
Consider also the opportunity cost of interest on the asset value of the cow. For the sake of this example, an interest rate of 6% is used which is midway between what a producer could expect to get in terms of return on investment if the money were placed in a certificate of deposit at 4%, and the cost of borrowing money at 8% to purchase the cow. If opportunity cost is calculated, assuming an average cow value of $3,000 per year at an interest rate of 6%, this is $180 per year.
Combining the $180 of opportunity cost of interest on the average cow market value together with the $460 of cow depreciation, results in a total of $640 per cow per year. If the cows wean on average an 88% calf crop per cow exposed to breeding, this is $727 per calf produced in depreciation and opportunity cost! If the producer receives an average of $420/cwt for weaned calves with an average calf weight of 525 pounds ($2,205/head), one third of total revenue generated would be needed to cover cow depreciation and opportunity cost.
The cow-calf producer will not get a physical notice for either cow depreciation or the opportunity cost of interest. However, depreciation is the value that is being lost as the cow eventually ages out of the herd, dies and/or as market prices decline. Opportunity cost is the expected return on the capital invested in the cow that could have been generated from an alternative investment.
Things for a cow-calf producer to ponder under current market conditions:
- Recognize the different categories of cost economically that are in unit cost of production for a cow-calf enterprise, including both depreciation and opportunity cost of interest on cow value.
- Understand how increasing cow prices impact the economic cost of producing a pound of weaned calf.
- Consider ways to get replacement cows into the herd at a lower cost and capture higher prices for cows when they leave the herd to reduce depreciation costs.
- Recognize that home raised replacements likely don’t cost $4,000 to produce, but this is their market value, and they could be sold to someone else at that price.
- Evaluate ways to capitalize on cow value. All income from home raised cows held for more than two years are taxed at a capital gains rate when sold. Financially these sales can have significant tax advantages as there is no self-employment tax on this income. Capital gains income is also taxed at a lower rate when compared to ordinary income, such as that from calf or yearling sales.
Cow-calf producers who recognize the economic cost of both cow depreciation and opportunity interest have taken the first step needed to address it. Once a producer sees the significance of these costs, they can then begin to consider what opportunities are available to reduce them.
Article by Aaron Berger, Nebraska Extension Livestock Educator.
