Most farms used the high milk prices of 2014 to make repairs or to replace machinery and equipment that were past repair. However, some farms also used this year to prepare for 2015, a year that couldn’t realistically parallel the record prices of 2014. This article presents strategies to help your business weather milk price cycles.
By: Timothy Beck and Heather Weeks, Penn State Extension
What happened to all that cash from 2014? Farms that made a 2015 cash flow plan with the Penn State Extension “Know Your Numbers” program this winter came face to face with the reality of a breakeven year after one of record highs. “How,” they asked, “could all that cash from 2014 just disappear?” Most farms used the high milk prices to make repairs to equipment and make capital purchases to replace machinery and equipment that were past repair. However, some farms also used this year to ensure that a 2015 year that couldn’t realistically parallel the record 2014 year wouldn’t be overwhelming.
A known phenomenon exists in milk pricing: the three year price cycle has been proven to exist (Nicholson, 2015). A simple internet search pulls up articles from the fall of 2014 referencing record highs in U.S. milk prices. Only four months later the headlines turned to “Milk Price Bust Expected” and “USDA projects four years of declining milk prices.” As futures markets started to show weakness last fall even while record milk checks were still coming in the mail, some farms were able to use those record prices to position themselves to weather the current downturn we are experiencing.
Source: National Agricultural Statistics Service (NASS) of the U.S. Department of Agriculture. Accessed here.
When prices are high, it is tempting to succumb to the attraction of the shiny and new. First and foremost, in order to position the farm business in a good situation for the inevitable downturn, avoid the temptation that the only tax management strategy is to increase capital purchases to avoid paying taxes. It leaves the farm vulnerable to cash deficits. Stay away from strategies that move money from the operating account to capital purchases. Instead, use that cash to pay down open accounts, vendor debt, credit cards, or lines of credit.
On the outflow side, prepaying expenses not only allows the business to capture prepayment discounts, but it reduces tax liability by using cash to cover future known expenses while not moving money to the capital fund. Then, the next time cash is needed from the operating fund to cover unexpected expenses or make up for milk income, it is available. A general figure is that for a low year, a farm needs six to eight months of cash on hand. In 2009 that accounted for about $1,000 per cow per year. In 2015 some experts estimate that number at around $500 per cow per year.
On the income side of the equation, deferring income, including milk income, can be an option for farms that use a cash accounting method on their taxes.
These principles come back to the balance sheet. Paying down current debt (accounts payable, lines of credit) strengthens the current position of the farm. Farms that have historically used this strategy have a more positive balance sheet and history that makes lenders more amenable to loaning these farms money when it is really needed. A good relationship with the lender can be invaluable. Credit cards are not viable options for financing farm operations. If a piece of equipment is really needed, finance it with the bank to keep the operating account available.
The goal is to stay solvent enough to weather the downturn and avoid major refinances after each low year.
Another strategy is to have a savings account separate from a farm checking to build a slush fund for low years. This tool is partly psychological: If it can’t be seen, it’s harder to spend. Cash kept in a checking account is easier to spend than cash kept in a separate account.
Finally, it is okay to pay taxes. While it is preferable to pay lower amounts, farms that never show a profit could send the wrong impression to lenders that may use the tax return as an indication of historical profitability.
If when assessing the farm’s income and expenses from 2014 the budget just didn’t show enough cash to use some of the strategies outlined here, then it is time to investigate where profitability leaks are occurring and make the necessary management changes. A good place to start is with a cash flow plan. After developing a plan, the farm is set to regularly track income and expenses for the dairy operation and other enterprises on the farm. Excellent farm financial accounting can sometimes be something as simple as having a good record keeping system and making sure it is up-to-date.
- Nicholson, C.F and M.W. Stephenson. 2015. Milk Price Cycles in the U.S. Dairy Supply Chain and Their Management Implications. Agribusiness. Doi: 10.1002/agr.21416
- Sim, S. January 17, 2015. “US Milk Price Bust Expected In 2015 After Last Year's Boom.” International Business Times. Accessed May 20, 2015.
- Dumas, C.R. February 18, 2015. “USDA projects four years of declining milk prices.” Capital Press. Accessed May 20, 2015.