Dairy Sense: Fixing Broken Financials

Starting off 2018 with a milk price less than $18/cwt is discouraging. For the last three years the average gross milk price received by the Penn State dairy herd has been 2015 – $18.10/cwt; 2016 – $16.84/cwt; and 2017 – $18.26/cwt. The average breakeven milk price for Pennsylvania dairy herds has been $18.50 or higher. The market is signaling that we have a surplus of product and milk prices will trend lower until supply and demand come into balance. It is not surprising that producers are in a state of shock and feel as though there is no light at the end of the tunnel. It is difficult to be overly optimistic but there are options for dealing with this current crisis. It will require keeping an open mind and recognizing that operating the dairy enterprise is no longer business as usual.

Troubleshooting financials is no different than with production. The first line of attack is to identify where the business is for liquidity, solvency, efficiency and profitability. This will require getting the financial statements up to date like the income statement, cash flow and balance sheets. Until these are accurately filled in there is nothing anyone can do to help.

Symptoms of poor liquidity are an increase in payables such as feed, fuel, fertilizer, repairs and others. This is compounded by added interest and late fees. This is often the first thing managers notice at the beginning of financial challenges. Depending on how severe the situation, options to help pay down bills are to sell assets such as feed, crops or animals. Family living expenses may have to be reduced. Caution should be taken on reducing farm production expenses. This tends to be the first knee-jerk reaction when cash flow is a problem, however, reductions in the wrong places could eventually come back to hurt income (i.e. milk production). Consolidating current debt into one loan could also be an option to reduce high interest charges on short-term money.

Poor solvency can threaten the survival of the farm. Over the long-term loans have usually been refinanced instead of being paid down when solvency is an issue. In extreme cases banks will not lend any more money to the operation. When dairies are in this situation drastic measures are required and usually result in the producer relinquishing some control. For example, selling off equipment and relying on custom hire to produce on-farm feeds. Before deciding on any alternatives, the impact on the cash flow should be examined as well as a plan for paying down debt.

Efficiency pertains mainly to the farm production system. Operating ratio, sales/assets, machinery to acres and interest to income are useful indicators on when to upgrade the dairy enterprise. Dairies should have a multi-year plan to examine when technologies, facilities and machinery should be upgraded or replaced. Any investment in the operation should increase the sales/assets or it’s not a good investment choice and will only further strain cash flow.

Return on assets is a common ratio to indicate the dairy’s profitability. This can be influenced by factors outside the producer’s control such as rising costs, decline in prices paid for crops, animals, and milk, and weather events such as droughts and floods. Profitability benefits from monitoring income and expenses routinely throughout the year to make adjustments as needed. Over time, profitability drives all the other financial aspects of the business. If the business is not profitable, the reasons must be identified and fixed or the business will not survive. Monitoring income over feed cost monthly against the breakeven would help flag potential problems sooner versus later.

Penn State Extension has tools and resources to determine a farm’s financial health. Expertise is available to examine bottlenecks to the production system. Producers are better positioned to make the right or best decision on the future of their business by knowing their numbers.

Action plan for improving profitability

Goal – Develop an income statement and a balance sheet for 2017 and project a cash flow plan for 2018

• Step 1: Working with a financial advisor or consultant, fill in the necessary information for the income statement and balance sheet.
• Step 2: Working with an extension specialist or consultant develop a cash flow plan for 2018.
• Step 3: Monitor IOFC monthly comparing to the farm’s breakeven number.

Economic perspective:

Monitoring must include an economic component to determine if a management strategy is working or not. For the lactating cows income over feed costs is a good way to check that feed costs are in line for the level of milk production. Starting with July 2014’s milk price, income over feed costs was calculated using average intake and production for the last six years from the Penn State dairy herd. The ration contained 63% forage consisting of corn silage, haylage and hay. The concentrate portion included corn grain, candy meal, sugar, canola meal, roasted soybeans, Optigen and a mineral vitamin mix. All market prices were used.

Also included are the feed costs for dry cows, springing heifers, pregnant heifers and growing heifers. The rations reflect what has been fed to these animal groups at the Penn State dairy herd. All market prices were used.

Income over feed cost using standardized rations and production data from the Penn State dairy herd.

Note: Penn State’s February milk price: $16.60/cwt; feed cost/cow: $5.49; average milk production: 85.0 lbs.

Feed cost/non-lactating animal/day.