Seven Rules of Equity Recovery

October 1, 2010 12:29 AM

There are seven rules of financial management that make or break a dairy farm, says Gary Sipiorski, a financial management consultant working with VitaPlus Corporation.

"Over time, you can break one or two of these rules, and you’ll probably survive," he told  Dairy Today this week here at World Dairy Expo.  "Break more than three and your operation probably won’t be functioning." The rules:

  1. Two:one liquidity. Current assets (cash, feed on hand) should be twice as large as current liabilities (accounts payables, 12 months of principal payments).
  2. Twenty percent or less of milk check being consumed by loan principal and interest.
  3. Eighty-five percent expense ratio or less which is the ratio of expenses versus net sales.
  4. $3,000 to $5,000 debt/cow. Once debt per cow exceeds $5,000, interest and principal payments make it extremely difficult to meet other expense and income needs.
  5. At least 30% equity. At lower levels, it makes it virtually impossible to borrow any money to bridge even short-term cash flow needs. Some lenders are now requiring up to 50% equity when lending for large pieces of equipment or facilities.
  6. Three-year asset turnover rate. If you have $1 million in assets, you should be generating at least $330,000 per year in gross returns. Any longer turnover suggests your assets simply aren’t generating returns quickly enough to sustain the business.
  7. Eight percent return on assets. Again, assets need to be providing a return to generate enough dollars to operate the business and provide adequate returns.

The simplest way to achieve these benchmarks is to generate as much gross income as possible while minimizing expenses. "Cows don’t understand the checkbook," says Sipiorski. "But they do understand cow comfort, being well fed and being bred back on time. If you do those three things, along with controlling expenses, you’ll go a long way in achieving these benchmarks."

The worst thing to do is to borrow money on low-return assets. Sipiorski says he recently met with a farm couple who thought they needed to buy a new combine. "But a $300,000 combine, used just a few weeks a year, usually isn’t a good investment in times like these. The couple would be better off using that money to invest in cows and generate more income," he says.


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Spell Check

10/1/2010 03:07 AM

  This guy has spent too much time within the cloistered halls of academia. It is evident from the articles he has little if any experience in Agriculture. All he is doing is parroting the dogma of old financial rules that are no longer applicable. Someday if he lives long enough, he will learn one thing, the only thing that matters in farming is "Cashflow". I really wish the academics would get real!

10/1/2010 05:17 AM

  Faust100F, Not that I'm agreeing 100% with the article's comments but what do you do when cashflow fails? That's where the liquidity and equity position comes into play. Every area of ag has had seasons or years where cashflow was inadequate. It's these other two areas that provide staying power through the down times.


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