Begin thinking marginally

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With milk prices significantly lower this year, dairy producers must do everything in their power to generate enough cash flow from the dairy to stay current on loans and pay bills. Cash flow is truly the “life blood” of all businesses.

In times of low milk prices, dairy producers may be inclined to lower their cost by postponing any and all investments that would trigger more borrowing. Similarly, dairy producers will often try to cut back on spending, such as cutting a feed additive out of the ration.

While avoiding debt and cost-cutting can be appropriate strategies in some cases, you should not become so cautious that you pass up opportunities to increase your income and improve cash flow. For example, you may benefit from purchasing additional cows or feeding a more expensive ration — if the amount of milk shipped from your dairy increases.

A new way of thinking
To determine which management tools will increase your cash flow, evaluate potential changes using a tool known as “marginal thinking.”

In marginal analysis — also referred to as partial budgeting — you determine the profitability that will result from a specific management change without including the cost of facilities and other capital expenses. This is done because you’re already paying these expenses, regardless of whether you make the management change or not. When you think marginally, you only consider the cost of a specific action.

For example, some dairy consultants claim that you can crowd your free-stall barns a bit without any loss in milk production or increased expenses in herd health. This allows you to operate your parlor at peak capacity.

In most cases, experts say that you can crowd your facility by 10 percent to 15 percent, especially in four-row barns. But, this also assumes that you have good enough management to handle the change.

The information in Table 1 reflects the yearly income and expenses a producer might incur by adding one more cow to a herd. The estimate suggests that a dairy producer with a 100 percent stocking rate can expect to generate roughly $775 of additional cash flow and net income by adding one cow.

Now, unless the producer paid cash for the extra cow, not all of the projected additional return would go directly to profits. A portion would be used to service the principal and interest on the loan used to finance the purchase of the cow.

The values presented in Table 2 are representative of the annual payments a dairy producer would have to make on a typical three-year loan used to purchase more cows. High interest rates and purchase prices result in a higher annual payment. However, even in the worst-case scenario, where the producer has to pay $1,800 for a cow and pay 11 percent interest on a loan, the producer will net nearly $40 of cash flow per year ($776.25-$736.58) from adding a cow to the herd.

Now, some might say that adding a cow for $40 to $130 of additional cash flow is more trouble than it’s worth. However, adding 50 cows, and taking your stocking rate from 105 percent to 115 percent, garners a net gain in cash flow of $2,000 to $6,500 per year. I cannot imagine someone turning down an opportunity to earn an extra return like that.

Remember, adding cow numbers is just one example. You should conduct a marginal analysis on fixing your facilities to improve cow comfort, adding fans to cool cows, or trying a feed additive. All of these are management strategies with the potential to boost income by increasing the volume of milk you sell. Talk to your accountant or financial consultant about using marginality on the dairy.

Bruce Jones is professor of agricultural & applied economics and member of the Center for Dairy Profitability team at the University of Wisconsin.



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