Fiscal Fitness

 

As the average size dairy gets larger and larger, and hopefully more efficient, a completely new level of management is entering into the dairy world.  

 

I have clients with $30 million (and larger) per annum in gross sales. While your operation may not be that large, many dairies still average in the $2 million to $4 million range. I would argue that this would define your dairy farm as at least a mid-sized business, if not greater. 

 

I see many producers who keep immaculate herd, reproductive and production records; however, many of those same producers have poor quality financial and money management records that may in turn lead to poor business decisions. I will many times drive home asking myself this very simple question, “Why?”

               

Why do many dairymen keep poor money management records? Is it because producers are part of an agricultural community that just accepts they are a small business (or at least perceive that thought process)? 

 

On the other hand, maybe it is because there has always been an adequate (again perceived) profit margin. Maybe the reason is dairymen have been price takers, not price makers -- in the fact the product is perishable and the co-ops or processors took care of the processing, marketing and receivables. Perhaps it is a little of each.

 

The bottom line: The need for financial records both historically and looking forward is critical to manage the mid-sized business.  

 

In my opinion, every producer should have cash flow projections for 6-12 months into the future. These are developed from historical data, input from the nutritionist, commodity brokers, veterinarians and perhaps business consultants. They should include all cash outflows and inflows, including capital improvements, living expenses, risk management strategies, principal reduction, and multi-month feed inventory purchases (silage, hay). These should be updated monthly (and timely) with actual numbers and variances in excess of an established amount researched. 

 

The last step is to add one month to the projection and make any alterations to upcoming months with new information that has been learned in the recent past. You should also have an inventory management system in place to measure feed that comes into the business (whether purchased and/or grown) and feed actually fed and consumed. Remember, more than 50% of your cost structure is feed.

 

Granted, this may not be a task that can be heaped onto the current management team and or individual owner; however, it is vital, so whether this information is sourced within or through outside or newly hired personnel, you will most likely find the monetary rewards great and be able to sleep a little better each night.

 

 

 

I have had the opportunity and honor to represent at least 40 Central California dairies since the beginning of 2011. It has been an extremely difficult time for many of these dairymen and their families.
 
It has been a real eye opener. Dairymen are among the hardest working people ever. They are also great risk takers, given the tremendous complexity of the dairy business. There is a risk everywhere you turn. 
 
Over the course of a year and a half, some generalized observations can be made. The hope is that readers would be able to apply these observations so as to prevent some of the heartache and hardship that results from not learning the lesson.

The points below are fairly general and are only the tip of the iceberg of my observations about dairymen and their financial acumen. Naturally, not all of these observations apply to every dairyman.
 
1.       It has been a real eye opener to realize that many dairymen do not really understand the consequences of their legal structure. I have heard numerous dairymen express a complete misunderstanding of what it means to be a general partner and have joint and several liability on all of the debts. It also has come as a surprise to realize how many dairies are sole proprietorships even though they are very large, sophisticated, complex businesses.  Lesson No. 1 is to make sure that you understand the consequences of whatever structure you are using.
 
2.       It has also come as a surprise to realize that many dairymen do not understand the nature and extent of the security interests and liens against their assets. Many have expressed a complete misunderstanding of what a blanket security is, such as that typically held by a commercial lender. So many dairymen seem to think that if the item of equipment or livestock is not shown on the list attached to the security agreement, it is free and clear. Not so. The second lesson to be learned is that dairymen would be well served to periodically double check the nature and extent of the liens against their assets.  
 
3.       It seems to come as a huge shock to many dairymen to learn that if their herd and other assets are liquidated they may, nonetheless, end up with a huge tax consequence. Dairymen are masters at playing the tax game and rolling things forward. However, when the merry-go-round stops, it can come as a rude shock to find out that hundreds of thousands of dollars are owed to Uncle Sam and the state governments. The third lesson to be learned is that dairymen would be well served to have a complete understanding of their tax situation and the consequences of a bankruptcy or liquidation.
 
4.       Dairymen often seem surprised to learn that there are a number of “secret liens.” These are liens that arise by statute such as the California Livestock Service Lien and the California Dairy Cattle Supply Lien. These are liens that can be placed against the assets of the dairymen without even obtaining a signature from them. It can tie up a lot of assets and cause great consternation with the dairymen's lender who has been “primed.” The fourth lesson to be learned here is that when times get tough there are a number of secret liens that can pop up and attach to the assets of dairymen.  
 
5.       This observation deals with titles to both real and personal property. Some dairy operations have been going on for generations, and they have transmuted from father, to brothers, to partnership, to limited liability company, etc. Yet many times the title is never changed. It has been a surprise to me to come across so many situations where the land is not in the name of the entity that is farming it or operating it. Similarly, major personal property assets may never have been properly titled. This can create real issues when times get tough. So, the fifth lesson is that dairymen need to make sure that the titles to their assets line up with the operating structure.
 
These five items are just a few of the many observations gleaned over the last year and a half.  In the next article, I will address lessons learned about the financial acumen level of dairymen and what might be done to upgrade that level.  
 
Riley Walter is an attorney and founder of the Central Valley-based Walter & Wilhelm Law Group, a law firm specializing in agribusiness, reorganization and bankruptcy. Contact him at 559-435-9800 or RileyWalter@W2LG.com.

 

As our cycles in the dairy industry continue, we are facing a period of marginal or negative cash flows. Since 2009, communication with your lender has become even more important (not that it wasn’t before), both from your standpoint and theirs. With increased regulations and scrutiny within the lending industry, quality and timely information becomes a necessity for your lender to be able to meet your needs. 

 

Below are three keys to successful communication with your lender.

 

1. Verbal communication with your lender.
Keep in touch with your lender on a regular basis. This doesn’t mean you need to call, email, text or drop in to visit him daily, but a short phone call goes a long way. If things aren’t going perfectly, increase the frequency and make sure he is in the loop with what is happening in your operation. The flip side is true as well: Know what your bank thinks of what is going on in the industry.  If you are having difficulties cash-flowing, chances are your neighbor is as well, and your lender already knows. What your lender doesn’t know is what you are thinking. How are the decisions you are making effecting your cash flow? Is your perspective of where the market is going the same as your lender? Let your lender know what your plans are going forward.  Be sure your lender is informed with what is going on in your operation, lenders don’t like surprises.

 

2. Numerical communication with your lender.
As most of the industry knows, reporting requirements by your lender have increased significantly over the past three years. This probably includes increased frequencies for position reports, financial statements and collateral inspections.  These requirements were born out of both increased regulatory pressure on your lender as well as the overall performance of the industry in 2009. With the difficult times we are in, provide your lender with your updated cash-flow projection. Don’t send him something that shows milk and feed prices that aren’t attainable.  Send him a cash flow that you can support by historical or actual current information. If you have a negative cash-flow projection, how are you going to cover the shortfall?  Do you expect your lender to cover it? Your feed supplier, local farmer, outside cash/investor?  This makes a huge difference in how your lender can help you. 

 

What changes are you going to make to improve your operational efficiencies? Are there any that can be quickly accomplished? How does it change the overall performance of your operations? Provide your lender something tangible that can be used to help him meet and support your needs. Whatever you provide your lender shouldn’t be a surprise since you have been communicating verbally with him on a regular basis. You know your business better than your lender does. Provide him with accurate timely information.  What you provide them helps him be a better lender and you a better client. 

 

3. Fiscal communication with your lender.
Most of you can provide a snow storm of information about your operation that can overwhelm your lender. Most lenders are not dairymen. If they were, why would they be lenders?  They are trained to look at information in a systematic way, which enables them to compare and evaluate your performance relative to your past performance, current industry conditions and your peers. In order to do that effectively, they require CPA-prepared accrual financial statements (review quality preferably). These financial statements are your communication method with your lender and his organization. Since they are prepared according to a standard set of accounting guidelines, they are a valuable communication tool for your lender within his organization.  This allows him to represent your operation in terms a decision maker will understand. 

 

Since financial statements are the primary tool a lender uses to evaluate your operating performance, they should be accurate, timely and representative of what you have been communicating to your lender.  A quality CPA firm can provide you with accurate, consistent, and timely financial statements that your lender will appreciate. With this level of reporting, you will recover in better financing.  The CPA information you provide to your lender is from an independent third party and validates the prior information/communication that you have provided on a more frequent basis. 

 

As with the prior communication, make sure you understand the financial statements you are providing your lender.  Spend the time to go over them with your CPA so you can answer most of the questions your lender will have about them. If you understand them and what the differences are between your information and your independent CPA financial statement, you will be ahead of the game.

 

Keep your communication conservative, consistent and pragmatic to keep a sound relationship with your lender.

 

 

By Steve Bodart, Lookout Ridge Consulting

 

The major drivers of a dairy’s cost of production are feed, labor and replacement costs. The first two are probably no surprise to anyone, but replacement costs are often not considered as drivers of cost of production. However, in some dairies, the replacement costs are greater than the labor costs.

 

Replacement costs as a component of the cost of production, are comprised of two different factors: heifer-rearing costs and dairy herd turnover.

 

Let’s start with heifer rearing costs. Once a manager understands these costs, he or she can begin to make some very important decisions: Should he or she sell excess heifers as calves? Should he or she sell excess heifers as springers, or should he or she manage for a higher turnover rate in the adult herd?

 

A key factor in replacement costs is understanding the cost to produce a heifer. Whether heifers are raised on-farm or custom-raised, the largest cost of raising a heifer is feed, followed by equal costs allocated to labor, capital, other production costs and overhead. When added up over the length of time required to get a baby calf to freshening, this adds up to $1,400-$1,600 per head.

In addition to the costs of all of the inputs required to develop a heifer, the manager must also consider that heifer calf’s own value, which represents an opportunity cost had the manager chosen to sell her. This brings the total cost to produce and raise a springing heifer to $1,600-$1,900. 

 

The next question is: What it would cost to purchase a springing heifer? In most parts of the country, this would be somewhere in the $1,400-$1,800 range. So one question a manager might ask himself is, “What is the potential for profit from raising heifers and selling excess heifers prior to freshening?” These calculations would suggest that those opportunities are probably minimal and, at the very least, inconsistent.

 

The next thing a manager must consider is how he’ll ultimately pay for the costs to develop that heifer. The potential contributions from that heifer to pay her rearing costs include her production, her future cull value and the value of future offspring, again taken as an opportunity cost. On average, a mature cow generates about $750 in profit per year or about $3.00 per cwt. The cull value might average about $675 when mortalities that do not generate any revenue are factored in. Offspring are valued here as a weighted average of heifer and bull calf values. 

 

So, once management has considered the costs and the potential revenue streams from that female to offset those costs, she needs to produce over 31,000 lb. of milk before she has covered her raising costs and her ongoing cost of production and is adding to the profitability of the operation.  In most operations, she is somewhere near peak milk in her second lactation before that occurs.

 

So, let’s think about managing replacement costs again. Dairies have a significant investment in developing a heifer, which does not differ dramatically whether raising her at the dairy or employing a custom heifer-raising operation. There is limited profit potential with raising excess heifers to be sold as springers. And finally, we need that cow to stay in the herd long enough to reach her second lactation before she generates profit for the producer.

 

With this in mind, we can think about how we might manage replacement costs in a commercial dairy. It includes avoiding situations where we raise excess heifers and building our herd such that we have optimized the proportion of cows we have that are in the profit window of their productive lives.

 
Steve Bodart’s dairy expertise began as a Livestock Production Specialist with the Co-op Equity Association, where he managed dairy rations and feed programs for Land O’Lakes. He continued his career with Land O’Lakes from 1989 to 1999 as the Dairy Business Trainer, and then the Dairy Business Specialist. Steve trained and provided dairy financial and consulting services and performed expansion and facility design, inventory, budget and operations management. In 1999, Steve became the CFO of Emerald Dairy, LLC, where he developed and managed several pieces of the operation and conducted direct consulting with select large dairy businesses.