Margin Mistakes

June 2, 2013 08:43 PM
Margin Mistakes

Calculating margins on your dairy is not as easy as it looks.

High feed costs—driven by drought, ethanol, export competition, you name it—means the margin between relatively strong milk prices and feed prices are being squeezed like no time since 2009.

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Calculating that exact margin, and then making decisions for management changes and forward pricing, becomes critical. Mistakes are far too easy to make. They, in turn, can cause dairy farmers to make the wrong decisions, says Greg Bethard, a dairy consultant with G&R Dairy Consulting in Blacksburg, Va.

One of the first mistakes is to use the locally "announced" blend price as your income number. That figure is an average and does reflect reality for your farm.

Most farms are now paid by pounds of each component sold—butterfat, protein, milk solids. They also probably receive premiums for quality, volume and basis. Deductions for hauling and advertising also must be subtracted.

If you simply use average prices, you could conclude that a herd with a tank average of 80 lb.per cow per day has far greater income than a herd with 70 lb. per cow per day. But what if the 80 lb. herd has low components and higher hauling costs because of the greater volume?

Bethard argues the income could be identical for the two herds, given component and hauling cost differences.

The key is to base your calculation on your milk check, which reflects exactly what you are getting paid for the components, quality and volume you’re shipping, he says.

Similar mistakes can be made when calculating feed prices in your income over feed cost (IOFC) margin calculations. Farmers (and sometimes their accountants) typically make three mistakes.

The first is to calculate feed costs based on a cash rather than on an accrual basis. "If accrual is not used, feed cost per cwt. is difficult to measure as the feed consumed may not correspond to the milk shipped, making the calculation irrelevant," Bethard says.

"Accrual usage requires measuring delivery (and by proxy, consumption) of feed over the period of time the financial statement is constructed. Feeding programs along with monthly inventory adjustments are ideal tools to measure accrual usage of feed," he says.

2. The second mistake is excluding dry cow and hospital pen feed costs in the IOFC calculation. He says feed costs per cwt. provide a long-term view of how your dairy is converting feed dollars in saleable milk. "It’s impacted by the price paid for feed, shrink, refusals, hospital, efficiency of converting feed into milk, dry cow numbers, dry period lengths and more," he says.

3. The third mistake is to value home-grown feed at the cost of raising that feed, rather than a market value. The whole point of IOFC margin analysis is to gauge the dairy as a separate enterprise.

"If feed markets drop and the advantage of cheap feed is gone, the dairy will lose its competitive advantage and may be at risk," Bethard says. "A farming enterprise is a great business for a dairy to engage in, but it should not subsidize the dairy business."

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