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October 2013 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.

What You Must Know to Implement Margin Management for Your Dairy

Oct 14, 2013

While margin management sounds straightforward, you need to have solid financial and production information to accurately predict your margin needs.

Bodart, Steve 3 12By Steve Bodart, Lookout Ridge Consulting

There has been a lot of discussion on managing risk on a dairy operation by focusing in on margin management. While margin management sounds straightforward, producers need to have solid financial and production information so that their margin needs can be accurately predicted. The purpose of margin management is to systematically evaluate the differential between an output and an input in order to make profitable short-term and long-term decisions.

Margin management is not focusing on a set price for milk or feed. Margin management focuses in on the differential that is necessary to cover all remaining expenses after feed expense, while still providing a return to the business.

Many producers develop an annual budget to use to help manage their business. Budgets are an excellent tool for producers to use to predict the profitability of their dairy. The problem with budgets is that the market is not stable, and with the huge swings seen in milk and feed prices over the past few years, making marketing decisions based on a budgeted price has not insured profitability.

In the past three years, milk prices have varied by as much as $8.00/cwt. within six months, corn by as much as $2.00/bu. in a month, soybean meal as much $250/ton in six months, and hay $120/ton in three months. The milk and feed markets do not necessarily always move together and sometimes move in opposite directions. As a result of these dramatic variances, dairy managers have often been on an emotional roller coaster as they try to make marketing decisions and often are second-guessing the decisions they have made.

It is critical to know your cost beyond feed expense to effectively manage margins. These costs are generally much more stable, and your budget is a great source for this information. In addition to knowing these expenses, it is also important to understand what type of profit margin you would like to obtain for your business.

Be realistic in establishing the profit margin. A good starting goal would be an 8%-10% return on assets. When non-feed expenses and the profit margin are added together and non-milk revenue is subtracted, the dairy is left with its desired margin over feed cost. Once the desired margin over feed cost is known, it is divided by the projected milk production for that time period to determine the desired margin over feed cost per cwt.

The volatile part of margin management is taking the milk price per cwt., and subtracting from it your total feed cost per cwt. to determine if the remainder will cover your desired margin over feed cost per cwt. When subtracting feed costs, include the cost of both purchased and home-raised feeds.

Marketing does come into play with margin management. You need to ensure that you have a balance between the amount of output (milk) you are marketing and the amount of input (feed) that you have marketed. If the percentage of your feed and milk that are forward-priced are not balanced, your dairy operation may be taking on more risk than it would have with no risk management program.

There will be times when the markets will not provide you the desired margin over feed cost that you are looking for in your business. During these times you will need to decide if the environment may present an opportunity down the road to obtain your desired margin over feed cost -- or if the environment is such that for this time period your business will need to settle for less than your desired return on assets. A critical number to know during these times is what the minimum margin over feed cost is necessary to maintain your net worth.

Each of your dairy businesses is unique, and it is key that you understand your leverage as you decide on your marketing decisions. When a dairy has more leverage, the amount of price risk that the business can handle is less, and this business may need to settle for a lower return on assets until it has improved its leverage position.

The focus of margin management is developing a system that helps ensures profitability of the business. It’s not a system to insure the highest milk price or the lowest feed cost. Margin management helps take the emotion out of marketing and helps you feel confident in your business decisions.

In 2001 Steve Bodart 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 715-308-9888 or sbodart@agstar.com.

Troubling Trend: Lenders Oversimplify Dairy Cash Flows

Oct 07, 2013

Dairy business expert Bob Matlick points out why banks' generic cash flow calculations can lead to poor lending decisions that may lull dairy producers into a false sense of security or insecurity.

p7 Fiscally Fit Bob MatlickBy Bob Matlick, Frazer LLP

We all know about the volatility that has reared its ugly head in the production dairy markets. The volatility is on both sides of the equation – inputs and outputs, with the ultimate tsunami hitting in 2009. A majority of the large dairy lenders have reacted to this volatility by tightening their credit underwriting standards.

We have seen lenders drop the maximum Loan-to-Value (LTV) ratio from 75% to 65% (or lower), the reduction of collateral values of personal and real property, and the inclusion of payables into the LTV formula. We have also been introduced to "burn rate" calculations, additional security in the real estate holdings, and monthly or more frequent position reports. All of these actions point to securing a better position in the collateral base so the lender and producer can weather the increasing volatility. Bottom line, the lender may be looking at collateral liquidation as the main source of repayment as compared to ongoing cash flow.

What I have not seen is an increased focus on monthly and seasonal cash-flow projections by the lenders or increased visibility of risk management strategies. In a typical borrowing relationship, multi-page Excel cash-flow projections are prepared by bank personnel and then approved or amended by the producer. These are usually prepared in a monthly format for a 12-month period. These cash flows, along with the collateral base, become the underpinning of the credit approval process.

I have reviewed bank cash flows and, in many cases, found a very generic approach to the process by creditors. For example, monthly production per cow will be projected at a static level without any consideration for seasonality, and feed consumption (dry matter intake) will be projected on a fixed basis for each monthly period, ignoring seasonality and price fluctuations. Yet, seasonality in all the major income and expense categories plays a large role in monthly cash flow, especially through warm summer months when production per cow suffers and farming and harvesting expenses are at their highest levels. This issue is even more pronounced in large dairy herds.

I have also seen milking cow numbers projected at a static head count year round, and annual farming expenses will simply be divided by 12 and inserted as an unchanging monthly number. In my opinion, these types of projected cash flow generalizations can cause poor lending decisions on behalf of creditors and may lull dairy producers into a false sense of security or insecurity.

Many banks and creditors will then propose
or enforce loan covenants based on these very generic cash flows. For example, "Milk income cannot vary by more than 10% of budget projections on a monthly basis," or "The monthly debt service must be equal to or greater than 1.25:1, budget to actual." While I understand the need by creditors to monitor cash flow (the main source of repayment for the loan(s) as opposed to collateral liquidation), I would encourage lenders and producers to understand and manage the monthly and seasonal variations that occur within a dairy operation.

This will take both effort and communication on both the producer and creditors behalf; however, it is crucial in developing a stable and functional credit arrangement with proper loan covenants. Without this full understanding of cash flow on both sides of the table, we will find creditors revert to collateral (Loan-to-Value) lenders with tighter and tighter restrictions to avoid the volatility.

Bob Matlick is a partner with the accounting firm of Frazer LLP. He has more than three decades of experience in the agriculture industry. Based in Visalia, Calif., Matlick is a management advisory specialist and provides business consulting services to the agriculture industry with an emphasis in the Western U.S. dairy industry. He has extensive experience in credit acquisition, buy/sell transactions, including tax-deferred exchanges, debt and management restructures of distressed agriculture financial situations, preparation of feasibility studies and facility relocation services. You can reach him at Bmatlick@frazerllp.com or at 559.732.4135 xxt. 107.
 

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