Wordless Wednesday: The Cost of Milk
Cost to Produce Milk does not include labor, value of owner management, or overhead (ie taxes)
$1.80 / gallon = $20.93 / cwt
Cost to Produce Milk does not include labor, value of owner management, or overhead (ie taxes)
$1.80 / gallon = $20.93 / cwt
A dairy cow spends 2 years growing before she starts producing an income on a dairy. That is a lot of time, money and resources to invest for a dairy producer. In a previous entry, I mentioned that heifer and dry cow feed expenses are often overlooked and can be a huge drain on profitability. It’s not uncommon to hear from people in the supporting industries or dairy producers themselves state that often, not enough emphasis is focused on heifers during those 2 years of growth before entering the milk herd.
In a recent article from the Journal of Dairy Science, titled “Effect of intensified feeding of heifer calves on growth, pubertal age, calving age, milk yield, and economics“, researchers from Michigan State University measured the growth and subsequent milk production for heifers fed either a commercial or intensified milk replacer. Please remember that this is ONE research experiment and the results may vary depending on the farm.
The interesting part of this research article was the economics of feeding the two systems. The higher protein milk replacer is more expensive and is fed at a higher rate. But are the returns (decreased age at first calving and milk production) on the investment really worth it?
To give you an idea of how the age at first calving can affect your farm’s profitability, below is a chart from an on-going extension research project being conducted at Penn State. The results from the first year will be published with the American Dairy Science Association Joint Annual Meeting Abstracts or you can contact me at email@example.com.
For every month your average age at first calving is over 23 months, it will cost you $150 per adult cow (lactating and dry) per year. The Penn State Profitability Assessment Dairy tool calculates this for you. From the table below, the highest potential economic loss was not age at first calving but it was the most prevalent (31 out of 37 farms had an economic loss due to delayed age at first calving).
Will feeding an intensive milk replacer program to your calves change age at first calving or milk production?
Age at calving in this particular study was 14 days earlier for animals fed the intensive milk replacer but the differences were not statistically significant. Milk yield (305 day, energy corrected milk) tended to be greater (not as strong of a statistical difference) for for heifers fed the intensive diet when corrected for genetic variation:
Control/ conventional fed calves corrected milk production = 21,425 lbs and intensive fed calves = 22,328 lbs.
Should you use an intensive milk replacer program? It depends. This program is not for every farm. The “intensified” title of this feeding regimen is no joke- it takes another level of management to make it work. Feeding a higher protein or higher protein/ fat milk replacer can be a topic of contention amongst nutritionists and heifer specialists. I have worked with both types of milk replacers and have seen the good and bad of both. The first thing that comes to mind is the feces: on an intensified milk replacer, the calves are often chronically loose. And just like with any other technology or feed additive on a dairy, it is not a solution to poor management. If your calf hutches or calf barns are dirty or poorly ventilated, changing your feeding program will not help you.
No matter what you decide to feed your calves and heifers, you need to determine your current cost of production. Can you afford to increase your costs? Depends on what the return is on this investment and if an intensive program would fit into your farm’s financial and management program. It will also depend on the milk price and feed costs. In this research paper they did an economic analysis to determine what economic conditions would favor feeding the intensive feeding program:
An intensified heifer feeding program is a management tool that may or may not increase your farm’s profitability. You have to determine if it will:
While collecting financial information of farms, I ask what is their owner draw. More often than not, I get one of three responses:
“I don’t take an owner draw”
“I don’t know”
Or even more frequently “Not enough”
Knowing all your expenses including owner draw is important in assessing your business.
What is owner draw?
I think people get owner draw confused with payroll when they don’t receive a pay stub like their employees. The majority of smaller dairies will have off-farm income that they consider what pays for their living expenses because it comes in a form of a paycheck. Often, when I dig deeper I discover that the owner draw tends to come out in bits and pieces: a little for groceries here, a doctor’s appointment there, Christmas gifts last year, etc. If these expenses are not tracked, they can be a bigger drain on your dairy’s profitability than you are aware of.
Whether you start to pull a set amount each month for personal expenses or keep better track of what you spend, either way you may be surprised at the amount. Dairy producers deserve to be paid for their hard work, but taking a draw from the farm willy-nilly can hurt more than help you.
*Remember: You can’t improve what you don’t measure!
With the Penn State Profitability Assessment Dairy Tool, we collect the owner draw amount (if known) and calculate a standard value based on the farm income:
Calculated value of owner`s labor and management (Owner Draw) = 2% of Total Revenue + $25,000.
The calculated number is a good place to start to measure whether or not you are valuing your labor and management accurately. The above equation can be used with multiple owners because it assumes with multiple owners, the total revenue will be greater.
What is accrual and cash based accounting?
From www.accountingcoach.com :
“Under the accrual basis of accounting, revenues are reported on the income statement when they are earned. (Under the cash basis of accounting, revenues are reported on the income statement when the cash is received.) Under the accrual basis of accounting, expenses are matched with the related revenues and/or are reported when the expense occurs, not when the cash is paid. The result of accrual accounting is an income statement that better measures the profitability of a company during a specific time period.”
For example, if you received a shipment of feed in October, 2010 but the bill doesn’t get paid until February, 2011, on a cash basis, that expense would be considered part of 2011 but on an accrual basis, it would be considered part of 2010’s expenses.
Why does it matter? For a business analysis, it’s important to match the expenses with the related income. The money you spent on feed to make milk in October may not have come out of your checkbook until February, but those expenses need to go with the matching income. In other words, how much money did it take to make money?
Milk checks also need to be accounted for on an accrual basis. This can be confusing since you receive December’s milk income in the middle of January. Also, when it comes to milk checks I have often seen dairymen record the net milk price as income rather than the gross milk check as income. Hauling and marketing should be considered an expense. Your gross milk income should be reported as your income and even though your net check has already taken out the hauling and marketing expenses, on an income expense report, they should be considered an expense.
But why does it matter?
“The only thing a cash-based system truly reports is how much cash is left, but it misses much of the explanation of how and when it was obtained or spent….A cash-based system may seem easier to maintain because all accounting events are tracked by the flow of cash in and out of the business. It’s essentially a checkbook.”
If you only look at the cash based approach to your dairy’s accounting system, you are missing an opportunity to analyze your business and see the true picture of your dairy’s profitability.
Still not convinced that an accurate business analysis is important? Ask your lender- he thinks it’s important. When you want to borrow money, they will look at financial ratios and analyze them to determine if they will grant you a loan. Accurately analyzing your business allows you to make improvements and create a stable lending opportunity.
Below is an example showing just milk income and feed expenses in August on a cash or accrual based accounting system. Even with this very simple example, there can be a huge difference between the methods. If you track Income Over Feed Costs (IOFC), the accrual basis is the only way to know how efficient you are at producing milk during that month.
Below is a graph based on USDA’s Agricultural Resource Management Survey of milk producers illustrating the cost of production for PA dairies from 2007 through 2010.
Determining your cost of production is essential for two main reasons:
When most people talk about the cost of production ($/cwt) they usually refer to the Total Operating Costs (red line). In PA, the operating costs ranged from from less than $14.00/ cwt to over $21.00/ cwt during 2007 through 2010. In 2009, the average PA dairy operating cost of production was higher than the US average and just slightly below in 2010.
Why does the cost of production vary so much?
Looking at the short list below of what is considered an operating costs, there are many variables that can change. Feed is usually the biggest expense on a dairy. Feed costs can be just as variable as milk prices (purple line). And with rising fuel prices and energy costs, all these expenses can quickly add up and influence other costs. When the cost of fuel increases, fuel costs on farm increase, purchased feed prices can increase, custom crop work prices can increase, and other services will all be affected.
“Operating Costs” includes:
Total feed costs (including purchased, home-raised, and grazed), Veterinary and medicine, Bedding, Marketing, Custom services, Fuel and utilities, Repairs, Other operating costs, Interest on operating capital
“Allocated Overhead” includes:
Hired labor, Opportunity costs of unpaid labor, Capital recovery of machinery and equipment, Cost of land, Taxes and insurance, General farm overhead
“Total Operating Costs” the the total of operating and allocated overhead.
How do I know if my cost of production is out of line?
Creating an income and expense report with all revenues and expenses listed for a year is a good place to start. The next step is to separate all your costs by overhead and operating costs AND in an accrual basis of accounting system, not cash. The next blog post will go into more detail of accrual versus cash basis of accounting but quickly, cash basis records expenses when they are paid, not when the service or product is received. In accrual, expenses and revenues are recorded when they are received, not necessarily when they are paid for.
After each area of your dairy operation’s expenses are separated out like below, you can see where there may be particular areas of concern. We have been working with PA dairy producers to develop these annual summaries. The chart below is a excerpt from a summary of 22 PA dairies from across the state, with different sized herds.
One area in particular we noticed as “flying under the radar” for most operators, was the dry cow and heifer feed costs. It easy to focus on the lactating cows because that is where the majority of your time is spent but the other animals on the operation can incur a big chink of the expenses.
Knowing you Cost of Production is the first step
Now that you have this information, you can calculate your breakeven for milk price or the class III price. A lot of dairymen can be wary about contracting milk or feed prices but knowing your breakeven a head of time can ensure that you are locking in a price that can guarantee cash flow.
Even with high milk prices right now, margins are still narrow and need to be tracked consistently. Milk prices are not expected to stay high forever and with this year’s rain/ lack of rain problems, this fall’s harvest will put additional pressure on dairy margins.
Virginia Ishler with the Penn State Extension Dairy team just released this timely article: Recommendations for Managing Profitability with a Poor Corn Crop
”Dairies must track Income Over Feed Cost (IOFC) because it is going to be more expensive to produce milk. Monitoring IOFC lets dairies determine if producing less milk is more economical than trying to get milk out of low-quality feeds or having to purchase a lot of feed.”
Below is a graph tracking IOFC on ~25 dairies in PA over the past year and a half. We use this tool to help dairy producers to track feed costs and margins on a monthly basis so they can make quick management decisions that can improve their margins.
The “high” range represents an IOFC where feed costs represent 40% of the gross milk income. The “low” range represents an IOFC where the feed costs represent 60% of the gross milk income. These ranges are a quick benchmarking tool to gauge whether or not feed costs are inline with milk production.
More information on the Penn State IOFC Dairy tool can be found at http://www.das.psu.edu/dairy-alliance/resources/income-over-feed-cost-tool
*All home-grown feed prices are based on market values and actual purchase price is used for purchased feed.