The producers who are most successful at using Cattle Forward Contracts are the ones who understand their cost of production, have profit targets and know how the price of their cattle relates to the Cattle Forward Contracts  price.  Cattle Forward Contracts have been used to lock in profits once prices have reached the required level. 

The producers who use Cattle Forward Contracts realize that managing price risk is as important as utilizing pasture and increasing weight gain efficiency.

What you need to know to manage price risks.

Before locking in prices using Cattle Forward Contracts there are two things producers must know, namely their cost of production and the historical difference between their particular cattle type and the Eastern Young Cattle Indicator. 

The Importance of Cost of Production and Target Setting

Knowing the cost of producing a kilogram of beef allows a producer to calculate the sale price required for a sustainable profit.  The profit margin required will be different for each cattle enterprise and will usually depend on historical margins achieved, expected market conditions and the cost of producing a kilogram of beef.  Once the cost of production and target margin are known the target sale price is easily calculated. Table 1 shows how a target price for a backgrounder is calculated, it is based on the following assumptions.

Purchase weight	280 kgs
Sale weight	452 kgs
Purchase Prices	$2.22/kg lwt
Cost of Gain	$1.00/kg lwt
Target Margin	20% return on costs
Purchase date	May
Sale date	November

Table 1:  Calculating target prices

Purchase weight Purchase price Cost/head   Weight gain Cost of gain ($/kg) Cost/head   Cost of production ($/hd)   Target Margin (20% ROC)   Target sale weight Target sale price Target sale price ($/kg lwt)

280 $2.22 $621.60   170 $1.00 $170.00   $791.60   $158.32   452 $949.92 $2.10

To achieve a 20% return on capital employed (ROC), the backgrounders target sale price is $2.10/kg lwt.

Relating Your Price to the Cattle Futures

Before producers can look at hedging their cattle sale price using Cattle Forward Contracts , the backgrounder should determine how their price relates to the Cattle Forward Contracts price. 

Basis (Historical Price Difference) = Historical Sale price minus the Historical EYCI.

By calculating this for the last 5 years worth of sales, as shown in table 2, the backgrounder finds his/her average basis is 12¢/kg liveweight.  That is, the price the feedlot pays him/her for his/her feeders is, on average, 12¢ higher than the prevailing EYCI. 

Table 2 also shows that the highest basis has been 20¢/kg lwt while the lowest was -2¢.

The EYCI is reported by the National Livestock Reporting Service in dressed weight and is converted into liveweight at 54% to compare liveweight sale prices.   
 
Table 2:  Calculating Basis

Year	Feeder Price (¢/kg lwt)	EYCI (¢/kg lwt)	Basis (¢/kg lwt)
Nov 2000 Nov 2001 Nov 2002 Nov 2003 Nov 2004 Nov 2005 Average	175 212 140 181 214 199 186.83	160 192 122 173 201 201 174.83	15 20 18 8 13 -2 12

The backgrounder now knows with relative certainty what his/her basis will be in November.  It is likely to be between -2¢ and 20¢/kg lwt with an expected value of 12¢. 

After understanding how the backgrounder's prices relate to the EYCI , the only variable left within this equation is what the EYCI is going to be in November.  

Take Home Messages:

• Many successful cattle producers know their cost of production and set target profit margins and therefore can calculate a target price.
• To relate a target price to futures prices, a producer must know the "basis" of their cattle to the Cattle Forward Contracts.
• The 'basis' is easily calculated by benchmarking historical sale and purchase prices against the prevailing EYCI on the day of transaction.

The Cattle Futures page will provide more information.