Using Replacement Strategies to Decrease Real Cow Depreciation

Profit Tip: Using Replacement Strategies to Decrease Real Cow Depreciation

February 2017

In accounting, real depreciation is an attempt to relate the change in value of an asset as it ages and/or declines in usefulness. For example, when you buy a car and drive off the dealer’s lot, it loses on average 11% of its initial value. Simply, the car is now worth less because it is a used car.

Depreciation expense represents the value difference between the current value of the asset and its value at the beginning of the time period being considered. Depreciation is valuable in the sense that it measures the costs of asset maintenance and tracks it over time. In order to remain in operation, an ongoing business requires its functional parts and assets to be maintained in productive condition.

Accounting for depreciation serves as a tool for tracking the progression of asset maintenance and its effects on the business, profitability, and net worth. Cow-calf producers and ranchers encounter a type of depreciation referred to as replacement costs. Like most agriculturally based businesses, the biological component of the business presents some unique challenges in predicting productivity and asset value changes. This uniqueness provides both challenges and opportunity for ranchers to build a myriad of strategies to streamline the economic performance of their operation. This article addresses the basis for developing economically viable replacement strategies.

The cow is the base productive unit of ranching. Cows, like many biological organisms, are each unique and vary in productive capacity and lifespan. This makes depreciation or replacement costs difficult to account for on a per head basis. Note, however, the decision to cull or buy is generally done on the individual animal basis.

Replacement costs are known to be one of the most expensive areas of the cow-calf production enterprise. An integrated strategic replacement plan can make the difference between an operation’s economic failure and success. The first key to building a viable replacement strategy is having accurate records on ages and herd productivity. The old axiom “If you can’t measure it, you can’t manage it” holds true in developing any kind of plan.

Most ongoing cow-calf enterprises will cull a certain number of cows annually; many times animals are purchased at a premium and sold at cull value. Ranching, like many agricultural enterprises, has negative or out flowing cash for most months of the year with very few positive cash flows (at harvest). As indicated, depreciation is one of these costs.

Depreciation is often referred to as a non-cash expense. This means as a cow’s value is increasing or decreasing, no cash changes hands. Depreciation helps track costs which, in the case of the ranching operation, relate directly to the cows. For simplicity and clarity, we present the straight-line method to estimate depreciation costs as expressed in the following equation:

IV – SV
PL
=
Depreciation
*IV (Initial Value); SV (Salvage Value); PL (Productive Lifespan)

The three primary components of this equation include Initial Value (IV), Salvage Value (SV), and Productive Lifespan (PL). By understanding the nature of these components, managers and decision makers may devise modifications in production and/or management practices to improve current economic performance. Each of the three parts of this equation relate directly to management or production choices. The initial value of replacement cows can be altered but potential impact on productivity has to be considered. The salvage value of an animal depends on how others perceive that animal’s value and may be altered, but those alterations come with costs. The average productive lifespan of the herd is a factor of environment, genetics, and management. Production/management choices in concert with the other two factors make the difference in success or failure of optimizing the cow’s productive lifespan. Manipulating each of these three factors comes with limitations, costs, and benefits.

There are several resources available that discuss depreciation/replacement strategies with focus on one or more of the three components of the depreciation equation (see resources below). The key here is to understand the effects that each of the three components has on productivity and depreciation expense. Broadly speaking, increasing initial value without altering anything else increases expenses; the opposite occurs when initial value is decreased. This is why during a period of increasing market prices, depreciation expense increases. An expensive cow purchased at the market’s peak will not be depreciated out until sometime in the future long after prices have fallen. In this case, expenses are increasing while revenue is shrinking. The market is likely to have the opposite effect on salvage value, As it increases, replacement costs decrease. A longer PL reduces annual expenses, which amounts to an overall reduction in replacement.

Additional ways to reduce initial value without affecting productivity include purchasing herd replacements that are younger and developing them yourself. Since replacement animals follow a seasonal pattern like terminal animals, purchases can be made to minimize costs. If adequate resources are available and/or purchased at the right price, retaining more of your own calves may be a viable option. In addition, if your development program and feed costs are suitable, non-pregnant animals or excess pregnant ones may be sold to recapture lost revenue from increased retention numbers. Be cautious with this strategy as retaining your own animals may cost less but it also affects revenues. These strategies vary in degree of success depending on whether cattle prices are trending up or down and whether management can use its resources to capture savings and lower costs. Other options include taking in heifers for a neighbor or others which may provide some economy of effort and/or added income, subsidizing the initial value.

The price received for a cow or heifer after being used in the productive process is considered the salvage value. Many producers will cull cows for being open at weaning or losing a calf during the grazing period. If sold immediately, the cow is at her lowest value. Young animals may have more value than aged ones but probably not significantly. Some producers have found ways to minimize the number of cows they sell of this type. Some have suggested increasing the breeding season to get later cycling cows pregnant and then sell them as bred cows or cow-calf pairs. Cull animals can also be retained and fed to heavier weights to increase returns. Additionally, cows can be sold at an age where they are still productive. For cows that have lost their calf, an option might be to graft on another calf.

The real challenge comes when the calf is lost in the later part of the grazing season. At this point, questions about the cow’s pregnancy and the cost of replacing her versus keeping her come into play. It makes no sense to sell the cow for cull value and incur the cost of a replacement at a much higher value if she is pregnant. If this cow is undesirable and should be culled, she may be sold later when she calves as a cow-calf pair. Many times the cost of keeping a dry cow is minimal compared to the cost of selling and repurchasing a replacement. Choice should always be made considering market conditions and resource conditions. The effect of each of these strategies is different from year to year depending on market conditions and ranch resource availability. For instance, during drought conditions, removing cows may work in favor of keeping the business economically viable.

Increases in the productive lifespan are controlled by management, environment, and production choices. For instance, hybrid vigor (heterosis) can increase cow longevity and reproductive performance. However, some operators will not run crossbred cows, making this option not viable. Other factors include using individual matings that reduce individual defects such as bad udders, large teats, poor legs, and other traits which would lead to a shortened productive lifespan. In some cases, longevity might be increased by certain nutritional regimes and by managing cows appropriately by size (for example, large cows may need more supplementation then smaller ones). Heifer selection should be based on management style and environment. Two- and three-year-old cows are still growing so special attention to them may help reduce dropout rates. Ensure that the mitigating actions used for this age class of cow return at least as much revenue as the costs incurred; otherwise, the productive lifespan gain will cost more than it returns, resulting in reduced profit.

The ideas discussed here do not make up an exhaustive list and may not be viable for particular operations or time periods. In summary, profit comes from two general areas: costs savings and increased revenues. Looking at the challenges ranchers are currently facing, it is wise to look closely at cow depreciation expenses and consider potential options for saving on costs and/or generating increased revenues.

Reference

Matt Stockton & Devin Broadhead
Nebraska Extension, University of Nebraska - Lincoln



 

click to listen  Listen to the BeefWatch Podcast on this topic

 

back to beef profit tips