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March 2012 Archive for Fiscal Fitness

RSS By: Dairy Today: Fiscal Fitness, Dairy Today

Financial management experts, lenders and accountants share ways for dairy producers to improve money and credit management. Look for help on budgets, taxes, loans, financial performance and even bankruptcy.

Count Your Heifer-Raising Costs as Part of Your Dairy’s Cost of Production

Mar 29, 2012

Replacement costs are not often considered as drivers of the cost of production. However, in some dairies, replacement costs are greater than labor expenses.


Bodart, Steve 3 12By 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.
 
In 2001 Steve joined Lookout Ridge Consulting (formerly AgStar Family Business Consulting) as a Senior Business Analyst, and in 2004 became a Senior Agribusiness Consultant and Dairy Industry Leader. Steve has a deep understanding of the family dairy business and large producer operations. Contact him at: Office: 715-688-6364; Cell: 715-928-2946 or steve.bodart@lookoutridgeconsulting.com
 

Financial Fitness Is a Must

Mar 19, 2012

Taking care of cows and growing feed remains important. But the other essential part of the business today is understanding the numbers that drive the dairy.

 
Gary Sipiorski VPBy Gary Sipiorski, Vita Plus Corporation
 
I often mention to dairy producers at meetings that, in the past, the business of milking cows meant taking care of the cows and growing crops to feed the livestock. Everyone worked hard to get all of the chores done. Today everyone is still working hard, but there is another part of the business that takes more time than before. That other important part now is understanding the numbers that drive the dairy.
 
Before 1980, dairy producers in many cases had 50% of their milkcheck to pay operating expenses, and the balance could be used for capital expenditures. Hard to believe, but if you were there you know what I mean. At no surprise to everyone today, 85% of the milkcheck is used for operating expenses. That leaves only 15% of the check left for other purchases. 
 
With tighter margins and no change in sight, dairy producers have to sit down and take time to know their numbers. Small margins can erode any profit in a hurry. Time needs to be spent during the day when a person’s mind is fresh, rather than late in the evening when the brain may not be as alert.
 
Financial fitness starts with doing and knowing your current balance sheet. It should be completed at the close of each year. The balance sheet contains the assets and liabilities of the dairy. The assets are broken down into current assets, which are cash, feed and items that will be turned into cash in 12 months. 
 
The next parts of the balance sheet are intermediate assets of livestock and machinery. Real depreciation should be taken on machinery because it does wear out. Even if you put new tires on the tractor, it is not worth more the next year. That is called maintenance, and the tractor still needs to be depreciated in value. Then, long-term assets such as land and buildings are valued under long-term assets. Buildings should likewise be properly depreciated. Add these three columns up and one comes up with total assets. 
 
The other side of the balance as it is known is the liability side. It starts with current liabilities, which are bills due over 30 days and principal due in the next 12 months. The intermediate liabilities are structured loans for cattle, machinery and lines of credit. The last parts of the liabilities are the loans for any real estate items. Adding the liabilities up, one comes up with total liabilities. Subtract total liabilities from total assets and the difference is your net worth or ownership equity. It is important to study and understand this important document. 
 
The other half of the important financials is the income and expense cash flows. These are different than just having your taxes completed. Because agriculture runs on a cash basis, extra prepaid expenses can be run into a tax year to lower income. Unpaid bills will not show up in the expenses. Income can be moved from one year to the next, depending on when the checks are made out. It is important for a dairy producer to have a clearer picture of what income and expenses really do occur in a given year. 
 
To be absolutely accurate, accrual adjustments should be made to the income statement. This means changes in feed inventories on hand. If there is less feed than a year ago, that is an accrual expense, because feed was used. If there is more on hand, that is registered as income, because cropping expenses were used to grow or buy the feed and it is available to generate income. Livestock accruals should be done in a similar way.   
 
The current year income statement needs to be completed and studied. One major factor to be looked at is the cost of producing 100 pounds of milk. Just as a long-distance runner needs to know his or her time to improve, dairy producers need to know what that last 100 pounds of milk cost to produce. The last three years of the income statements need to be studied with all three years averaged out. A projected budget for the coming year needs to completed and tracked as the year moves on to see how projections match up. Make sure you spend extra time with the five major expenses and put some logic to the numbers.
 
If some of these terms are not real clear, hire yourself a trainer, such as a financial consultant or good accountant, to help you understand what financial fitness is.
 
Gary Sipiorski has a long career in the banking industry, doing business primarily with dairy producers. He has been associated with the Citizens State Bank of Loyal, the Graduate School of Banking in Austin, Texas, the Independent Community Bankers of America, the Governor’s Task Force on Growing Agriculture in Wisconsin, and the Advisory Council on Agriculture, Industry and Labor for the Federal Reserve Bank of Chicago. In 2008, he joined the Wisconsin-based nutrition firm, Vita Plus Corporation, where he is dairy development manager. Contact him at 608-250-4267 or GSipiorski@vitaplus.com.

Inside the Banker’s Mind

Mar 05, 2012

Efficient management is key to surviving the dairy business.

 
By Rabobank N.A.

Amid fluctuating inputs costs and the roller coaster ride that milk prices have ridden in the last few years, there’s no telling what a dairy’s financial portfolio might look like from one year to the next.
 
In a post-2009-dairy-crisis world, some banks -- at least the ones still lending to the dairy business -- are beginning to look at the big picture of overall business management as an indicator of whether the operation is a survivor for the long haul. The picture is different for each operation seeking financing, but before a dairyman makes the phone call to his beloved banker, he/she should take steps to prepare for a smooth review process.

CPA-Prepared, Accrual-Basis Financial Statements
 
Yes, certified public accountants don’t normally come cheap, but paying their fees and taking their advice could mean the difference between keeping the lights on or off at the milking parlor. Accrual-basis financial statements prepared by a CPA provide banks with the best snapshot of profit and loss for a given fiscal year. Because tax returns can include deferred income and prepaid expenses, banks are interested in seeing the actual numbers of how the business performed each fiscal year.
 
Using Financial Statements as a Business Tool
 
Often dairy operations rush to get their financial statements together for the proverbial trip to the bank or a visit from their banker. However, if dairymen are taking the effort and time for the statements to be prepared, they should use them as an ongoing tool to manage their business. At a minimum, operations should review their financials on a semi-annual basis to make sure they’re on track and see where adjustments need to be made. Bankers want to know that dairymen are in tune with these statements and understand how the business is performing at any given time. Simply stating that the feed bill is higher than the milk check or vice versa just isn’t enough.
 
Monthly Borrowing Base Reports
 
Input costs such as feed and fuel can change dramatically within a month’s time, and that’s where dairies get in trouble. Dairymen need to know their feed costs, even going so far as to split out grain versus roughage. By running a once-a-month borrowing base report, commonly known as an inventory report, dairymen can get a better handle on feed and herd costs and compare them against their debt. Again, such reporting isn’t only for a lender to review—a monthly inventory snapshot allows a producer to make adjustments quickly, instead of finding him or herself in trouble at a quarterly, semi-annual or annual check-in point.
 
Understand Your Breakeven Costs
 
Calculating a dairy’s breakeven costs is relatively simple, but how a dairyman uses that information is what matters. To determine breakeven, producers need to determine their cost of production, debt cost (including the new debt they want to take on) and cost of living (be practical here, especially with the cost of dependents). From those costs, understand that a banker wants to know a worst-case scenario—e.g., if milk prices drop, how long can a producer keep up with those costs. If a producer can only stay afloat for six months, he or she is at higher risk than someone who’s hedged to be able to last three years.
 
Vertical Integration
 
With turbulent feed costs, bankers want to know that an operation can sustain itself in a scenario when the gap widens between feed costs and milk prices. Producers who grow their own feed and find other ways to vertically integrate themselves generally find themselves in better favor with bankers. By identifying vertical integration points, such as raising their own calves and trucking their own milk (as just two examples), dairymen can again reduce the costs of production and have more margin to service their debts.
 
Succession Planning

Today’s banker wants to be with a customer for the long term but needs reassurance that an operation has a plan for generational shifts. Whether from voluntary retirement or the sudden passing of a family member, producers need to have a plan on paper to make sure that potential problems, such as estate taxes and family antics, won’t affect the dairy’s ability to service its debt obligations.
 
Rabobank, N.A. is a California community bank and a leading provider of agricultural financing and full-service banking products to California consumers, businesses and the agriculture industry. To learn more visit: www.rabobankamerica.com
 
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