Using a partial budget to analyze the adoption of technology.

By Greg Steele, AgStar Financial Services

Editor’s note: This is Part II of Steele’s look at how to determine if Precision Dairy Farming justifies its cost. Part I can be found here. 

When considering investing in a new technology for your dairy business, the first step is to figure out how the change will affect your operation’s profitability.

A good method to determine the impact on the profitability of your business is a partial budget. This simple and efficient tool can help you define the financial impact of incremental changes. A partial budget helps you segment and analyze the costs that will change and assume other costs such as feed costs or crop production costs will remain unaffected.

Partial budgets are built on the theory that small changes can have meaningful results. Done correctly, a partial budget will help you see how your proposed technology may influence your income and/or expenses. Will your income increase or decrease? Will your expenses rise or fall? A partial budget can provide the answers.

When beginning this exercise, it’s vital to include all income and expense items that will be affected by the change. For example, if milk production is expected to increase, then revenues will increase. If you use less feed, feed costs will likely go down. A partial budget analysis provides you with an easy-to-see, side-by-side comparison.

Let’s examine the following theoretical situation: A new technology that is gaining acceptance quickly is a cow sensor monitoring system that provides data via your mobile phone. For this example, we’ll compare the technology’s claimed benefit of improving reproductive efficiency with improved conception and pregnancy rate while simultaneously reducing drug and hormone therapy costs in the dairy herd.

Let’s assume the herd size in question is 500 head and the cost to install and implement is $200/cow for a total of $100,000. The herd presently has a pregnancy rate of 20% and a heat detection rate of 55%. In addition, the herd currently is using a timed AI program for breeding.

The projected annual savings are as follows: drugs costs will be reduced $12/cow and labor costs will go down $60/cow. It is also anticipated that heat detection will increase to 65% with a pregnancy rate increase to 24%. This improvement is expected to lower the days in milk from 185 to 175. We will assume the economic value of this change is $5/cow/day change in days in milk or $25,000 in added income.

OK, let’s run the numbers as we should have all the information we need to create a partial budget on this.

The above analysis assumes reducing days in milk will add an estimated $25,000 in added milk revenue. Additional changes to net income occur from reduced drug and labor costs by $36,000, for a total net income increase of $61,000. In this situation, there would be no decrease in net income to account for. The cost of the sensors, however, would be a consideration. We can reasonably spread the $100,000 cost of these devices over a three-year useful life and, as such, include one-third of the investment cost, $33,333, plus interest costs of $3,300 in the budget.

The analysis illustrates that adopting the technology will result in an annual net benefit of $24,367. Additionally, the entire investment is paid for in less than 24 months, bringing future year’s potential benefits even higher.

Key to this analysis is using realistic assumptions on economic benefits of the expected changes. Remember, this budgeting process can only estimate the potential financial results, not guarantee them. A good practice is to repeat the analysis by using different assumptions as this will provide an idea about the degree of risk involved when considering a change. Keep in mind management practices and unplanned circumstances can alter the outcome.

All in all, partial budgeting can be a very helpful method when analyzing the benefits of investing in new technology. This systematic approach can assist the dairy manager in making informed financial decisions.

Greg Steele is vice president, dairy industry, for AgStar Financial Services. He can be reached
at greg.steele@agstar.com.

From robotic milking to precision feed management, these new technologies promise great benefits. How will you determine if they justify their cost?

By Greg Steele, AgStar Financial Services

It has now been several years since Global Positioning Systems were introduced to U.S. crop farms. Now it’s a common management tool for many tasks associated with planting, monitoring and harvesting crops. There is no question that this type of technology has optimized management in many areas by improvement in matching fertility need to soil type, enhanced water and soil protection, better economics, and improved decision- making--just to name a few.

Precision ag: not just for grain producers

So, what do these new technologies have to do with the dairy industry? Quite a bit. If you made it to World Ag Expo, World Dairy Expo or any of the many state and regional dairy industry trade events, you likely noticed the introduction of tools and concepts that improve management, replace labor and enhance milk production. These technologies can be grouped into four categories:

1. Robotic milking
2. Feed management
3. Automated calf feeding
4. Herd management sensors

Robotic milkers: This precision technology continues to gain acceptance in the dairy industry. Several companies have released their version of the robotic milkers, which were designed specifically to replace the manual task routinely done by humans to milk cows two, three or even four times a day. The benefits of robotic milkers may include:

• Reduced labor costs
• Decreased need for employee management
• Consistent preparation and milking procedures
• Improved production, milk quality and udder health

Automated calf feeders: Feeding dairy calves manually is a two-or three-times-a-day task. The development of automated calf feeders has brought many benefits, specifically:

• Increased labor efficiency
• Improved immune system development
• Environment conducive to social interaction and welfare
• Maximized growth potential, which can positively influence future milk production

Key considerations when implementing automated calf feedings systems are building layout and machine type. Good planning to design a coordinated system is a requirement.

Herd management sensors: Wouldn’t it be great to be able to monitor cow welfare 24 hours a day, seven days a week? New sensor technology, which works in a variety of environments — from freestall barns to loose housing to pasture — makes this a reality and can help dairy producers:

• Increase reproductive performance
• Detect sick cows one to two days earlier
• Eliminate manual data entry

Precision feed management: Given the rapid rise in feed and grain prices, precision feed management has become very important over the past several years. Technology has gone beyond the common truck scale and computerized software designed to monitor feed costs per ingredient and adjust for shrink and moisture. State-of-the-art feed management devices can measure out various feed ingredients to prescribed levels of accuracy. The benefits of precision feed systems may include:

• Increased feed efficiency
• The ability to match nutrients fed to individual cow needs
• Feeding requirements based on dry matter intake, body weight changes and milk yield
• Inventory management

All of these technologies tout improved economic performance. Most of them provide significant statistics and data points that can improve management intervention and decisions. Precision technology does indeed hold great promise for the industry; however, what will be the cost to adopt these technologies?

Your lender will want to understand the cost benefit analysis of the investment. He or she will also need to know how it meets the investment test of improving efficiency, reducing costs and increasing production. How does a dairyman determine if these are wise investments that will provide the returns that justify the cost?

Preparing a partial budget can help. This decision-making framework compares the costs and benefits of alternatives being evaluated by a dairy business. It will focus only on the changes in income and expenses that would result from implementing a specific system such as a calf feeding system. Then further determination can be made for how the precision technology investment impacts the overall profit and loss statement for the dairy business.

Next in this series on precision farm technologies, Steele will examine how to use a partial budget as a decision tool and how it may benefit your dairy operation.

Greg Steele is vice president, dairy industry, for AgStar Financial Services. He can be reached
at greg.steele@agstar.com.

Take the steps that will enable your dairy operation to strengthen and evolve into a stronger financial position.

By Mark A. Brady, CPA, CVA, Partner
Cooper Norman Certified Public Accountants

The past few years have dramatically changed how numerous industries operate, especially the dairy industry. In the dairy industry, we have seen many articles and posts about the need to be "Fiscally Fit" in various publications and media settings. Much of the discussion was in regard to the need to change with the changing times. For most dairy operations, it became a necessity for survival.

We are now beginning to see numerous posts and articles that discuss items of generally more positive tones. We need to remember that no one can see the future. As our dairy operations and the economy change, we will need to look for and take steps that enable our business operations to strengthen and evolve into stronger financial positions. That will allow them to withstand future downturns that we know are inevitable and extremely unpredictable.

If we were able to put together the management team spoken about in the previous posts and have survived to now, there is a good chance we are headed in the right management direction. We must keep in mind that whether the economy has begun to change for the positive or not, the things discussed earlier while in the down market are still extremely vital. The continuation of those management-type decisions while in upward swinging markets can allow a business to get out in front of the curve and move to the forefront of the industry.

Remember, the real key is to have a management team that has the future success and continuity of the business at heart. They should be looking ahead to identify ways to accomplish things like:

1. Which creditors should be caught up first?
2. How can we improve our lending relationship?
3. How we can rebuild the equity lost by the current owners?
4. How can we put funds away for older, less active owners?
5. Is it time to begin ownership transition to the next generation since values are depressed from the down economy?

Every business operation must review his or her current position (financial and market) and begin asking, answering and preparing to implement plans to successfully complete the items needed to improve, propel and enable their success into the future. The business might even need to reshape the structure of the company, its management and/or its employee workforce.

The list above is in no way all-inclusive and is not what every business needs to accomplish. As indicated, the responsibility of the management team is to identify the needs of your business operations and put into motion the plans to accomplish the desired results.

As accountants, we cannot agree more with some of the most recent posts discussing the importance of having up-to-date bookkeeping and record-keeping systems and a set of personal benchmarking criteria. It is basically impossible for a management team to implement management strategies, let alone set goals, when it cannot identify the position the operations are currently in. Appropriate accounting records, ratios, budgets and projections all assist management in making timely, realistic, achievable plans.

Since, the last few years have been so tight dairy operations have generally operating on an extremely tight, crisis mode. It becomes vital to each operation and owner to be sure that they are planning for the future of longer than just one day. The last few years have been extremely brutal on the dairy industry and not many members of other industries would be able to survive the way many of you in the dairy industry have been able too. If the current economy is truly improved for the dairy industry at all, and we have positioned our operations appropriately, the potential successes are sure to come.

Based in Idaho, Mark A. Brady is a partner with the firm of Cooper Norman Certified Public Accountants. Brady is a Certified Public Accountant (CPA) and a Certified Valuation Analyst (CVA). He grew up on a Montana dairy. Contact him at 208-733-6581 or mbrady@coopernorman.com.

While it’s never too late to start planning, the key is to start in your early years.

By Gary Sipiorski, Vita Plus Corporation

You will not find a group of people more dedicated to their careers than dairy producers. Dairy producers surround themselves with people, living creatures and crops that must be attended to 365¼ days a year. They often get so wound up in what they do that they forget time passes by and one day they will not be able to do the physical and mental work required to run the business.

So, are you preparing for that time down the road? I do not have a Series 7 (stockbroker’s) license, so I cannot give specifics of what to invest in, but I can suggest choices of directions you have. The key is your dairy will have to be passed on to someone. That may be a family member(s) or the next buyer.

Many dairy producers say, "My dairy is my investment choice and my retirement. So I plow everything I have back into my farm!" Others say, "I am never going to leave, they will have to bury me here!" One way or another, you are going to have to build up enough equity to give you choices when that day comes to turn you over or the farm over to someone else. You cannot have two bankers on the farm. You can be the banker or a lender will be borrowing money to the next owner. So, back to our question at hand, where does that leave you for your retirement?

1. If you have dairy that supports a single family, you will need to have most of the debt satisfied when you decide to retire. Most of these types of farms have stuck every dollar right back into the farm for machinery, cattle, land, buildings or other things the farm needs. Many times there is a spouse that works off of the farm. That income will be used for family living or buying farm items that are needed. A lot of times the off-farm income will have some type of a retirement plan tied to it, like a teacher’s retirement or other investment opportunities. That can be used in a retirement plan as well. I have also known dairy producers who do manage to squirrel money away in investments off of the dairy so they actually do have a nest egg put away.

The key to any off farm investment is to start early. Find a trusted investment person who can help you set up a retirement savings and earnings account with monthly deposits for the future. Now, when time comes to pass on the farm, the relative or new buyer can borrow money from a bank to pay off the retiring couple. The retiring couple may be in a position to offer a land contact and get paid back over a period of time, basically turning the farm asset into an annuity that pays back monthly. Here again, the farm has to be mostly debt-free so the first couple is not also having to make bank payments. The cash flow of the farm is a key factor here as well. So make sure you have a productive herd of cows that can generate enough income to support the next generation’s payments.

2. If you have a larger multi-family dairy, you may have some additional options. With an adequate cash flow, invest money can be set aside off of the dairy for a future retirement. Here again, it is important to start early. Therefore, when retirement comes, there are off-the-farm investments to fund a new lifestyle. This farm as well needs to be in a strong financial equity position. There is nothing wrong with these farms carrying debt. It just has to be able to manage the payments. Borrowed money must be able to generate at least twice the return that it is borrowed at.

Many times the owner(s) of a larger dairy are managing people and making management decisions. They are doing a lot of mental work. They can continue this style for many years. The key is to train the next generation to make decisions so they can slowly phase themselves out as retirement nears. Stock or ownership transfers can occur with the next generation, assuming the business debt and responsibilities. The first generation can be paid out over time with a monthly income or all at once if lender borrowing can be arranged. Tax planning is critical and any time a farm transfer is being considered on any size farm.

It is never too late to start planning for retirement. It really should start in the early years, because some day you will not be able to do what you are doing today.

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. 

Don’t just sprinkle the money around. Here are smart ways to use your improved cash flow as you come out of the pricing crisis.

By Riley Walter, attorney

In prior posts, I have focused on things that I have learned and observed from representing numerous Central California dairymen during the depths of the dairy crisis.

However, now that there may be some light at the end of the tunnel, it might be a good idea to turn attention to what dairymen might do once there is a positive margin between the milk price and the feed price.

Having seen dairies come out of crises in the past, I know that one of the first things dairymen tend to do is spread the "excess" margin over all of their creditors. They apparently believe that sprinkling the money over the entire creditor body is a good way to go. It is not. Not all creditors are equal. You need to use the enhanced cash flow on those you need or those who have priority. Don't just sprinkle the money around. Pay the CPA you are going to need as you move forward. Fix items of deferred maintenance, especially environmental problems. Catch up on insurance and utilities. Work on rebuilding the herd. You need to use the additional cash flow in a rifle-like manner, not a shotgun.

Second, do not be surprised when there is an avalanche of creditor lawsuits seeking to collect on long overdue vendor bills. As soon as there is excess cash flow, you can be sure that the dam will break and a large number of lawsuits will be filed as creditors jockey to get ahead of other creditors.

Third, please get your accounting, bookkeeping and recordkeeping systems up to par. A lot of folks have let this slip during the crisis either because of the stress or because they did not feel they could call upon their accountants when they could not pay them. You really want to get this cleaned up. At some point, we all hope, lenders will be back in the market, and they are only going to lend to those who have superior financial and recordkeeping systems. The old days are over. You are going to have to demonstrate substantial management and financial acumen going into the future. Being "good with cows" is not going to get you a loan.

Fourth, for those of you in California, it is reasonable to expect that the environmental regulatory floodgate is going to open. Recent court rulings make it pretty clear that dairymen face substantial regulatory compliance costs in the near future, and you need to be contemplating this as your finances improve. If you sprinkle the money to overall existing creditors, you may well be unable to maintain environmental compliance.

Last, and this is maybe hard to comprehend, many dairymen have been able to avoid filing Chapter 11 due to extremely hard work and just by hunkering down. However, many of these dairymen are saddled with huge amounts of vendor debt. That debt is not going to go away even though cash flow improves. Some, maybe many, of these dairymen will need to consider filing Chapter 11 to propose plans to shed debt. To do this, they really need to get their financial report systems up to par. If these dairymen are able to demonstrate "feasibility," they will likely be able to shed considerable unsecured debt.

So, here’s hoping that the reports of enhanced cash flow are true.

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.