Dairy Profitability

by Rebecca White

During a recent meeting this question was raised: “When our dairy producers come to us and ask what they should  do about the feed costs and milk prices, what are we suppose to tell them? This seems impossible”.

My response: tell them to stop being victims to the market. Maybe my harsh answer came out because it was the end of the day or maybe I have been to countless meetings discussing cost of production and solutions to decrease farms’ breakeven milk price and keep getting asked the same question. At point are we putting to much blame on external factors?

I don’t question that we need milk price reform but until that happens, we must work with the system that is in place.

Some dairies today, and even through 2009, have been doing well. What makes them different than the dairies who “can’t seem to catch a break”? That is a pretty complex issue but part of it comes down to the mind set of the dairy operator: they don’t let themselves be victims of the markets.

3 keys to controlling your destiny:

1) Know you cost of production and breakeven margin, IOFC, and/ or Class III milk price at all times

Knowing and understanding you cost of production and everything that goes into will allow you to see where changes need to be made to decrease your costs or increase revenue.  If your breakeven is too high, figure out why – is your milk production not high enough? Is your current IOFC too low because of rising feed costs? Do something about it now.

2) Know your feed inventories

It frustrates me to no end when I hear “I’m running out of corn silage in a week” or even better “I ran out yesterday”. The best solution to this problem is probably a more expensive one than if you had planned on how much you could feed to certain groups to make it last as long as possible. And if you still needed to purchased additional feeds, you could have done  so when the markets are favorable instead of forced to buy whatever is available. In a resent article from Dairy Herd Management Magazine “What did we learn from this year’s drought?” a dairy operation knew that they had enough corn silage to last them the year but they would have to buy shelled corn. Their forward thinking and planning allowed them to set a plan in motion. Another dairy operation forward contracted land rent and purchased feed. It may be expensive but he know exactly what those costs are going to be and can now react to them.

3) Understand how to forward contract milk and feed prices and other risk management options

Even if you don’t contract your feed or milk, get set up to do so in  moments notice, you can react to changes in the markets more readily. Livestock Gross Margin (LGM) insurance is a contentious topic, not always available, and some have not been pleased with the outcomes. Regardless, you should still understand how it works, what your breakeven class III milk price, and corn and soy equivalents of purchased and total feed for your lactating cows at all times. Talk to a trusted insurance agent who has experience with LGM policies and know that if you call them the Friday morning of an open LGM period, they won’t have time for you. Call a few weeks before to get an account set up and give them a chance to understand your needs and what they can offer you.

These 3 things will help allow you to react to the markets immediately, not be victimized by them. Sitting back and choosing to not do any of these things is the riskiest way to dairy farm today. Drought, high feed costs, low milk prices, tight margins, and lack of resources is the new normal. The days of grin and bear the tough times are over. Now is the time to take control of your farm and its future.

 
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Income Over Feed Costs 101: Back to Basics

By Rebecca White

The terms ‘income over feed cost (IOFC)’ and ‘milk margin’ are used frequently in articles, presentations and conversations regarding profitability, feed costs, and milk prices in the dairy industry. The Penn State Extension Dairy team utilizes the IOFC tool in education and assistance to dairy producers across the state. Dairy producers and agri-business professionals alike often ask for an explanation of what IOFC actually means and how it relates to making decisions on the farm. To help clear up any confusion (and make this tool useful) here is a basic introduction with some examples of how it can be used in a variety of situations.

Starting with the end goal in mind

There are endless financial and production numbers that can be tracked on a dairy operation. Information can be useful for a farm but if it can’t help make decisions why waste time collecting it? Income over feed cost (IOFC) is a monthly assessment that will estimate whether or not feed costs are in line for the milk production. Before starting to track IOFC or any information on your farm, ask yourself: what will this tell me about my farm and how can I use this information to make decisions to improve my farm’s profitability?

The basics: What is IOFC and how is it calculated?

Simply put – IOFC is milk income minus the feed cost of the lactating cows. For example, if a farm ships an average of 70 lbs per cow per day and receives a gross milk price of $20.00/cwt, the milk income is $14.00 per cow per day. Subtract a feed cost of $6.00 per cow per day and the IOFC equals $8.00 per cow per day. The milk margin is the same number but on a cwt basis: $11.43/cwt.

Is this a good or a bad IOFC? What are the benchmarks?

Feed is usually the largest and most variable expense on a dairy operation. The percentage of milk income that is spent on feed is a quick approximation of whether or not feed costs are in line with the milk production. For the example above, the percent of income that is going towards the lactating cow feed is 43%. The goal is to maintain an IOFC where feed cost is less than 40% of milk income. The less money that is spent on feed means more money that is available to pay for the remaining farm expenses.

*Feed costs should be determined for your home-raised feeds but Penn State has market values available if unknown.

Why not just focus on increasing milk production?

Analyzing milk production or feed costs independent of one another does not allow decisions to be made specific to a farm. For example, Farm A has a 10 lbs milk production advantage over Farm B which equals $2.20 greater milk income per cow per day. However, Farm A’s feed cost is $2.61 greater than Farm B’s. The more favorable IOFC ends up being on Farm B.

But when the milk price looks good, why worry?

When milk prices are up, getting feed costs in line will help when milk prices do eventually drop. For example if milk price decreased to $18.00/cwt, Farm A’s IOFC will decrease to $6.16 per cow per day, leaving less income to pay for the remaining farm expenses whereas Farm B’s IOFC only decreased to $6.97 per cow. Planning ahead and minimizing feed costs even during high milk prices increases resilience during low milk prices. By the time feed costs can be decreased on Farm A, significant amounts of income will have already been lost.

Next Step: calculating breakeven IOFC. What are the “remaining farm expenses”?

Calculating the current IOFC on a monthly basis is a good start but is it enough to cover the rest of the farm expenses? Simply put, the breakeven IOFC is the amount of milk income needed to pay the remaining farm expenses after feeding the lactating cows. The breakeven IOFC is calculated based off historical income and expenses and expected future expenses and borrowings. The Penn State Extension Dairy team has developed a comprehensive tool that determines breakeven IOFC that includes a calculation for the value of home raised feeds. For more information, please contact the Penn State Extension Dairy Team.

Below is an example based on a real Pennsylvania dairy farm that will be called Farm C. Farm C has a relatively low cost of production of $16.63 per cwt or $10.61 per cow per day. Cost of production is low partly due to high quality feeds grown on farm and minimal purchased feed. The cost of production minus the feed costs of lactating cows (purchased and home-raised) minus the non-milk income equals a $6.53 IOFC breakeven per cow per day. In other words, after feeding the lactating cows, Farm C needs $6.53 per cow per day of milk income to pay the rest of the farm expenses. With a milk price of $18.75/cwt, Farm C has a positive balance of $1.86 per cow per day over breakeven. **Please note that the breakeven IOFC is based off an annual average. Differences in cash flow expenses throughout the year will affect the monthly cost of production and cash flow.**

In example 2, Farm C has locked in purchased lactating cow feed costs; however, milk price has decreased to $16.20/cwt. The breakeven remains the same but the available IOFC has now decreased to $6.73 from $8.39 when milk price was $18.75/cwt. The balance is now only $0.20 per cow per day over breakeven.

In example 3, milk price has stayed the same at $16.20/cwt but cost of production increased to $11.18 per cow; purchased dry cow mineral and calf starter price has increased because Farm C did not lock in those feeds and a piece of machinery had unexpected repairs. Now the breakeven is $7.10 per cow, $0.57 higher than before. The IOFC balance is now a loss of -$0.37 per cow per day under breakeven.

Take Home Message: one number by itself (milk production, milk price or feed price), won’t provide enough information to make decisions that will positively improve farm profitability.  Calculating breakeven IOFC will help determine if expenses need to be reduced, production needs to increase, the farm needs to expand, production or risk management practices should change or if the markets allow milk prices and or feed prices to be locked in.

For more information, please contact the Penn State Extension Dairy Team.  Contact Rebecca White at (814) 863-3917 or raw43@psu.edu or visit this website: www.das.psu.edu/dairy-alliance/resources/income-over-feed-cost-tool

Cows, Cash, and Communities: What Do Dairy Farms Mean to You?

By Rebecca White

(EDITOR’S NOTE: The following originally appeared in the October 7, 2011 issue of Farmshine newspaper)

For some, the only interaction with dairy farming is the trip to the grocery store for a gallon of milk. For others, it is a daily interaction with dairy farming whether it’s milking cows, making cheese or delivering milk. But even for those who haven’t ever been on a dairy farm, their lives are influenced by Pennsylvania’s largest industry – agriculture. Within agriculture, dairy represents the greatest share of total receipts at about 40%.

During this year’s Ag Progress Days in Rock Springs, PA, the Penn State Extension Dairy Team gave a series of presentations to the attendees. One of these presentations included a talk about how dairy farming affects all citizens in the Commonwealth. Dairy producers and city dwellers alike attended the presentation to learn about the positive effects dairy farming has on the economics of the Commonwealth.

One of the positive benefits dairy farming has on the state is job creation. There are over a half million dairy cows in the Commonwealth and for every nine cows, one job is created for a total of 60,000 jobs statewide. Not all of those workers are employed at the farm; many make their careers in the sales and service sectors of the industry that support farm operation. Those half million dairy cows produce over 1.2 billion gallons of milk every year in PA. It takes a lot of time, money and resources to produce a gallon of milk. For instance, before a mature cow produces milk, it has to grow and be cared for over two years.

The average retail milk price in Philadelphia and Pittsburgh from 2007 through 2010 was $3.60 per gallon. Dairy producers get paid for every 100 pounds of raw milk or hundredweight (cwt). If a gallon of milk cost $3.60 that equals to $41.86 per cwt. From 2007 through 2010, Pennsylvania dairy producers received an average of $18.39 per cwt or $1.65 per gallon of milk. Milk prices can vary quite a bit. During that same time period the lowest price was $12.90 and the highest was $23.90 per cwt.  However, the percentage of the retail milk price dairy producers receives remains relatively consistent (35 to 55%; based on USDA Agricultural Marketing Service data).

On average, a dairy producer is paid $1.65 per gallon of milk, but how much does it cost to produce that gallon? Keeping the cost of production low is essential to maintain profitability for the dairy producer but also helps maintain the low cost of food for the consumer. The Pennsylvania State Extension Dairy Team helps dairy producers determine their cost of production and pinpoint areas that can be improved to increase financial sustainability.
When cost of production on dairy operations is discussed, it usually only refers to the total operating costs per cwt. In PA, the operating costs ranged from less than $14.00 per cwt to over $21.00 per cwt during 2007 through 2010 based on USDA’s Agricultural Resource Management Survey of milk producers (http://www.ers.usda.gov/Data/CostsAndReturns/monthlymilkcosts.htm).

In 2009, the average PA dairy operating cost of production was higher than the US average and just slightly below in 2010. The average cost of production during that time was $16.78 per cwt or $1.44 per gallon. That leaves $0.21 per gallon for a dairy producer to pay himself, his labor, and other overhead costs.

Total Operating Costs

Total operating costs include total feed costs (including purchased, home-raised, and grazed), veterinary and medicine, bedding, marketing, custom services, fuel and utilities, repairs, and interest on operating capital. Allocated overhead (hired labor, rent, taxes, owner draw, etc) is not included in the operating costs. On the chart below, the blue line represents the gross milk price in PA during 2007-2010 and the red line is the total operating costs on PA dairy operations.  The difference between those lines is what is left over to pay for those allocated overhead costs. During low milk price cycles, overhead costs may not be covered on many farms. Milk prices dropped in 2006 and 2009; what is in store for 2012?

Feed is usually the biggest expense on a dairy and can be variable like milk prices. On the graph the purchased feed costs are in green. 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, delivered purchased feed prices can increase, custom crop work prices can increase, and other services will all be affected.

What can dairy producers do to control their costs?

Determining the cost of production for a dairy operation is essential for two main reasons: 1) assessing how financially efficient the operation is at producing milk currently and historically, and 2) determining the break-even margin or milk price so decisions such as contracting milk prices or feed costs can be made effectively.

Beginning in mid 2008 and continuing through November of 2009, the gross milk price was not enough to pay for just the operating costs. These numbers are based on a sample of dairy operations and some assumptions were made. However, the message still stays the same: if a dairy has a high cost of production, when milk prices drop, so does profit.

There are many costs associated with dairy farming so figuring out a place to start analyzing can feel overwhelming. The Penn State Extension Dairy team has multiple resources and programs that can start dairy producers on the journey to cutting costs and increasing profitability. The Profitability Assessment Dairy Tool (PA Dairy Tool) is a comprehensive financial and production analysis that pinpoints areas of economic loss on a dairy. The follow-up drill down tools further focus in on the cause of the economic loss. Working with a profit team, a consultant, or a member of the Extension Dairy Team, dairy producers can utilize these resources to cut costs.

Beginning in January of 2012, the Penn State Extension Dairy Team will host a series of one-day workshops called “Managing Your Milk Margin to Improve Your Dairy’s Cash Flow”  where dairy producers will determine their own farm’s breakeven class III price and discuss their areas of cost of production that could be improved. A series of conference calls will also be offered starting in January called “Show me the Money; Strategies for Dairy Farm Profitability”. A summary of PA dairy farm data will be discussed with Extension team specialist and agribusiness professionals.

Producers interested in using these valuable tools on their dairy or attending the workshops or conference calls are invited to contact the Penn State Extension Dairy Team for more information. Contact Rebecca White at (814) 863-3917 or raw43@psu.edu or visit this website: http://www.das.psu.edu/research-extension/dairy/dairy-science/pa-tool

Wordless Wednesday: The Cost of Milk

Visual used at this year's Ag Progress Days in Rock Springs, PA

Cost to Produce Milk does not include labor, value of owner management, or overhead (ie taxes)

$1.80 / gallon = $20.93 / cwt

 
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How does feeding your dairy calves affect whole-farm economics?

by Rebecca White

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 raw43@psu.edu.

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.

Other Observations:

• Feed efficiency was greater for calves on the intensified feeding program
• Feed costs per day averaged $1.27 higher for the intensified program
• Heifers fed the conventional diet during the preweaning period tended to lose more weight during early lactation
• Milk fat and milk protein percentages and amounts were not different
• Milk income and first lactation feed costs did not differ
• There were no differences in net milk returns
• If milk yield is corrected for energy and genetic variation, then milk yield and milk income tended to be higher for the intensively fed calves

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:

• Increasing milk price from $16/cwt to $22.40/cwt, increased the total returns to the intensive program $41/heifer
• Increasing feed costs for postweaned heifers and lactating cows by 20%  decreased net milk returns by $5/heifer and slightly decreased the economic value of the intensive diet
• Increasing labor and supply costs by 5% for the intensive feeding program would raise the cost by $5/heifer

Bottom Line:

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:

1. work with your farm’s management style and facilities
2. be worth the investment (time, labor, feed costs)
3. change the age at first calving or milk production

Resources:

• Penn State’s website on dairy heifer nutrition and management   http://www.das.psu.edu/research-extension/dairy/nutrition/heifers
• Heifer Economics                                                               http://www.das.psu.edu/research-extension/dairy/nutrition/pdf/heiferecon.pdf
•  Labor Management for Heifer Rearing               http://www.das.psu.edu/research-extension/dairy/nutrition/pdf/labor-management-for-heifer-raising.pdf

 How much does it cost to produce milk?

by Rebecca White

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:

1. Assess how financially efficient you are at producing milk currently and historically
2. Determining your break-even

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.

Excerpt from expense summary for 22 PA dairy herds ($/cwt)

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.

Bottom Line: Just because you can’t control the price of milk, doesn’t mean you can’t control how much it costs you to make it.

What is Profitability?

by Rebecca White

The definition of profitability from acountingcoach.com is:

“A word to describe whether a company is able to earn more revenues than expenses.”

Sounds simple enough. Is your dairy profitable? Was your dairy profitable this past month? This past year? The past five years?

Dairy farm profitability is more complicated than whether you have money in the checking account at the end of the month or not. An Income Statement or a Profit and Loss Statement for a period of time (usually for a one-year period) determines if a dairy farm is profitable. It reports all revenues and expenses and the net income.

Another important financial statement for your dairy is the Balance Sheet. This will list all your assets and liabilities and is used for other indicators of profitability.

Other Measures of Financial Health Common on Dairies

There is more than one way to size up the financial health of a dairy operation. Here is a short list of measures or indicators of profitability and each topic area will be explain in more detail in following blog posts to come!

Cost of production: How much does it cost you to produce one hundred pounds of milk?

Debt per cow: how much debt does each cow have to carry?

Financial ratios: Return on Assets (ROA), Asset Turnover Ratio (ATR), Operating Expense Ratio (OER), Debt: Asset

Where do I Start?

If you haven’t been involved with a profitability assessment of your dairy operation before, it can seem overwhelming. Ask your accountant or loan officer for an explanation of your income statement and balance sheet. Usually, loan officers develop balance sheets for their clients before a new loan is granted. Income Statements use information from your Schedule F from your farm income taxes or from your accounting software. Click here to find out how.

More resources can be found on our website at www.das.psu.edu

For more information about profitability assessments, visit our Managing for Dairy Profitability website

Questions? Comments? Please feel free to contact us directly or leave a response below.