Profit in the Details Is your expansion feasible?

September 19, 2008 07:00 PM
 
Dan Little

Whether you are expanding or simply renovating an existing facility, a detailed feasibility analysis might save you thousands of dollars and hours of time. A basic feasibility analysis can be broken down into three major areas: financial, technical and market.

Financial. This is the portion of the analysis that usually comes to mind concerning a new idea or project. First, the scope and size of the project must be determined. This is followed by detailed estimates that include permitting, excavation, building materials, labor, livestock, equipment, electrical, water, and other components of the project.

After all costs are determined, add at least a 15% contingency during the planning phase. Any additional operating costs should also be added to the total cost to ensure that you have adequate operating capital available for the entire project.

Next, a source and use of funds can be summarized and a cash flow projection prepared to determine if you have sufficient equity available to support the construction and implementation of your project. The cash flow projection will provide you with an estimate of the extent of an operating line of credit that will be necessary to cover costs until the operation is in full production.

It is especially important to project the cow flow and milk production through the first years of the project since the percentage of cows milking will drop dramatically 12 to 16 months after start-up.

Finally, the cash flow projections must be merged with the initial balance sheet information to project the return on investment or return on equity of the project. Fundamentally, if the cost to borrow money is greater than the return on investment, you might want to reconsider the project.

Start-up costs will drive the balance sheet net worth lower in the first year. But the project should start increasing net worth in year two.

Technical. This aspect of the analysis addresses key issues such as cow comfort, labor efficiency, ventilation, lighting and building design. It is critical to evaluate the projected space allocations for the dairy to ensure that pre- and post-fresh pens have adequate bunk space.

Ventilation and lighting specifications must be met in all phases of production. Detailed drawings are necessary in order to evaluate cow flow and people traffic. This is also a good time to reevaluate feed storage and manure management plans to ensure that all environmental regulations are being met.

Market. This is the most neglected aspect of most dairy feasibilities. Many dairy producers assume that their milk market will always exist and that feed supplies will not change. It is better to take a more realistic approach. A complete feasibility analysis addresses market factors, competition and backup strategies in the event a supplier or processor disappears from the local market.

Market sensitivities are useful tools for evaluating the impact that price changes will have on the financial parameters that were projected in the financial phase of the feasibility analysis. These sensitivities often lead to detailed discussions of contingency plans in the event that the project does not move forward as planned.

While it may seem difficult to predict the outcome of a proposed project, I personally agree with the saying that "the best way to predict the future is to create it!”


Dan Little, DVM, manages DairyNet's Dairy Solutions Center in Brookings, SD. Contact him at dlittle@dairynet2000.com 
 

Bonus content:

  • You are reading an extended version of this column that appeared in the September issue.

 

 

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