What began as a tiny flicker has finally flared into a stronger flame of economic recovery for the dairy industry. As of early November, butter prices are on the rise, and cash cheese markets have improved. According to the latest USDA figures at press-time, the all-milk price for 2010 is expected to average between $16.05 and $16.95 per hundredweight. That’s up $4 from this year’s all-milk price.

Dairy exports are looking up, too, though it’s been a bit of a bumpy ride with August export declines giving back much of the gains of June and July. Still, August exports were valued at $193.2 million, the highest figure posted this year, according to trade data released by USDA’s Foreign Agricultural Service on Oct. 9.

While these points are cause for optimism as we turn the calendar page to 2010, there are plenty of reasons to remain cautious. As the cliché goes, we’re not out of the woods yet, especially at the farm level.

Tough road ahead

“We’re looking at another six to nine months of tough sledding in the dairy industry,” says Darrell Dunteman, partner at Bonnett and Dunteman, LLC, Certified Public Accountants and Consultants based in Illinois. “While we’re seeing some increase in price lately, we’re going to have to sweat this one out a while.”

Negative cash-flows are still in play for a significant number of dairy farmers, agrees Tim Swenson, a business consultant with Lookout Ridge Consulting based in Baldwin, Wis. 

Lingering low milk prices, combined with high input cost for much of the year, ate big holes in nearly every farmer’s equity (the value of your ownership in the business).   How big the loss depends, of course, on where you started. But, it’s not unheard of for equity positions to be down 50 percent or more.

The big challenge, Dunteman says, is for operations that are down to equity positions of 30 to 40 percent. This is dangerously close to the point of no return. “Once you get to this ‘hard deck” or equity floor, it doesn’t matter if the dairy economy turns around in six months,” he explains. “It’s too late for your business.”

Meanwhile, everyone needs time and capital to restore lost equity and return to better financial footing.

Slow payback

Part of that equation probably involves slow vender repayment.

“Farmers are generally debt-averse people,” says Swenson. “They want to pay back what they owe, so their first inclination is to pay all vendors as soon as possible when milk checks begin to rise again.” But, this may not be the best strategy in the long run, and one of the reasons the entire dairy economy faces a lengthy recovery period.

If you do not look ahead and give yourself a cushion —like a full month’s operating expenses in reserve — you could quickly return to a poor or negative cash-flow position, he says, especially if the recovery stalls or reverses. The fact that real estate taxes and springtime inputs loom just around the corner only add to the challenge.

“My advice is to not pay anything off immediately that does not directly affect milk going out the door,” says Swenson. Once you’ve paid for items like feed, labor, loan payments and utilities, then you can determine whether you have remaining funds to give vendors something on account.

“I know this is difficult, because these are your neighbors, the people you go to church with, the parents of your children’s friends,” Swenson adds. “But they will have to wait so that your farm can pull through. We’re just at the bottom step of this recovery.”

It’s the economy, stupid

The slow recovery of the general U.S. economy is one of the biggest stumbling blocks to the dairy economic recovery. Economists have declared the recession over, but the message hasn’t necessarily trickled down to Main Street, especially with national unemployment hovering around 10 percent (and much higher in a myriad of areas) and continued sluggish job and wage growth. For the most part, consumers have been in a miserly mood when it comes to spending.

On the bright side, it is an uptick in consumer demand that’s driving the current dairy price increase.

Will prices rise to the levels of 2007 and 2008? asks Cameron Thraen, Ohio State University extension dairy economist. That depends, he says, on the depth of the retrenchment and the speed at with which the domestic and international demand returns.

“I believe that another 100,000 to 140,000 milk cows need to exit the industry to restore normal profit margins,” he says. “This would put the U.S. industry back to the January 2004 level with a milk supply that will balance against domestic demand, plus some small amount of export demand. Make no mistake about this reduction — it will be painful.”

Meanwhile, unknown in all of this is what form dairy market reform will take, if it occurs at all.

So while you follow the path to economic recovery, watch out for the woods.

Library Corner

A myriad of resources are available to help you perform diagnostics on your dairy’s financial performance and assist in your future plans:

Keys to consider

As you work your way out of this downturn, here are a few points to consider:

  • Work with your banker on refinancing and business planning. It’s always best to have a good relationship with him before there are signs of trouble, and even more critical now. You may have to consider real estate mortgages or real estate refinancing to help you get through this period. Also make sure term debt is properly amoritized for the appropriate life of the corresponding asset.
  • Cull strongly. You cannot afford to support a cow that is losing money. Consider limited liquidation, and cull as much as half of your herd if necessary if you need to raise cash. “Just keep in mind that this affects your cash flow and income potential,” says Darrell Dunteman, partner at Bonnett and Dunteman, LLC, Certified Public Accountants and Consultants. “As a mentor once told me, be careful that you don’t drop a quarter to save a nickel.”
  • Use zero-based accounting to evaluate every purchase. (See “6 ways to monitor your financial position,” June 2009 Dairy Herd Management.)
  • Bond with your nutritionist. Aim for “best-cost” rations that do not decrease milk production.
  • Don’t cut corners or underestimate values, advises Tim Swenson, a business consultant with Lookout Ridge Consulting. “Continually evaluate your operation through the use of budgeting, monitoring and sensitivity analyses. Know where your numbers come from, and then use them to make independent decisions as to what is best for your dairy.”
  • Develop a sound marketing plan. Your plan must fit your dairy, your expertise and your comfort level. “Then use it,” says Swenson. “That doesn’t mean lock in as much milk as you can right now. It means figure out what reduces risk for your dairy and then massage and execute your plan as additional information becomes available.”

Finally, remember that cash-flow is king. If you must borrow money to meet payroll and buy feed, carefully calculate your cash-flow needs and take a hard look at your balance sheet.

“Ask yourself, how much debt can you take on and still maintain a viable business,” recommends Dunteman. At some point, you will have too much debt and must liquidate your operation. The strength of your balance sheet (your equity) will determine how much you can borrow and how long you can survive.