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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By Rebecca White

Do you utilize technology to improve your dairy production or fall back on it when your management techniques are inadequate?

Today at the Penn State Dept of Animal Science Seminar, Dr.  Kathy Soder from the USDA-ARS-Pasture Systems and Watershed Management Lab, presented “Opportunities, Challenges, and Research Efforts in the Northeastern Organic Dairy Industry”.  Dr. Soder discussed why dairy producers chose to transition to organic and some of the pros and cons. One of the pros was producing milk under organic standards and regulations  forced the dairy operators to become better managers, or at least the ones who were able to succeed.

Some of the rules that are included in organic dairy production include exclusion of chemicals in crop production and “no” antibiotics for animals. I use “no” because if an animal continues to be sick, antibiotics must be used for welfare concerns however, they are not allowed back into the herd.

Because of the limited amount of technology you can use on an organic operation, the managers are forced to address issues immediately or prevent them from happening in the first place in order to succeed and stay in business. By no means does this indicate conventional dairies are not addressing issues or preventing them but I raise the question: are some dairies relying on technology to fix mistakes rather than enhance productivity?

Technologies have helped the dairy industry and will continue to allow more opportunities to produce abundant, healthy and affordable food for years to come. Utilizing these technologies should allow dairy operations to produce milk more efficiently and improve profitability. However, if the technology is fixing poor management, where have we gained on efficiency? If you utilize a product that will increase your milk production by 10 lbs but cows aren’t being bred back in a timely manor or age at first calving is 28 months, did you gain profits or was your investment a wash?

I fully support the utilization of products that can help dairy producers. But I remind you to always bring it back to the basics: if your management is not meeting your full potential how will a band-aid fix a bullet wound?

I often get questions about types of feed or new products to increase milk production and I usually answer back with questions about their cow comfort. The bottleneck or the most limiting factor that is inhibiting maximum production is usually a management issue on these farms. Access to water and feed, clean stalls, bunk space, sprinklers and fans,  and quality forages are all areas that can be improved on these dairies but often overlooked especially when the promise of a quick fix is an option.

I hope all farmers will be allowed to make decisions on their own farms without being over regulated but with the current atmosphere I fear that more regulations will be put in place deciding what technology can be utilized. I urge all dairy producers to be the most effective managers and utilize technology as an enhancement to their profitability, not a crutch.
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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

Accrual versus Cash basis: What does it mean and why it’s important to dairy farming

by Rebecca White

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.

Example

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.

Wordless Wednesday- Income Over Feed Costs (IOFC)

by Rebecca White

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.

Welcome!

Dairy Farming during economically straining times can be hard enough. Keeping up with market trends or educating yourself with risk management options can seem overwhelming and most people don’t start dairy farming to become accountants. This blog will be an educational discussion about dairy farm profitability that will highlight key areas of risk management education, basic financial information, and areas of dairy farm management.

Who Should Read this Blog?

Dairy producers and agribusiness professionals serving the dairy industry.  Even if you are working in a part of the dairy sector that focuses on other areas other than specifically dairy farm profitability or risk management, this is an opportunity to educate yourself on the basics and help you better serve your clients.

We hope you enjoy this blog and find it to be a helpful resource. Please feel free to comment or send suggestions!

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.