Evaluate debt wisely

 Resize text         Printer-friendly version of this article Printer-friendly version of this article

It's apparent that the pork industry has focused more on the business side of management than the dairy industry. Terms like "competitive position" indicate that for pork producers to be profitable in the next century, they must continually improve and reinvest in the business. Shouldn't the same management goals apply to dairy as well?

As dairy farms become more technologically advanced, coupled with a high capital investment, it becomes necessary to adopt financial performance systems that help you make profitable decisions. Production parameters, such as calving interval and culling rate, need to be coupled with return on assets, return on equity, net profit margin, leverage and asset turnover. In order to maximize returns, dairy producers need to understand how to manage assets and capital expenditures.

Most producers are familiar with the standard calculations for return on assets (ROA) and return on equity (ROE). These measures are calculated from values found on the profit-and-loss statement and balance sheet of the business. However, if the ROA and ROE are found to be substandard, there is another financial tool, that breaks these two ratios down for review.

The DuPont model breaks ROE into three parts, providing a means to evaluate three key areas – assets, expenses and debt management. Managing these three areas of the business can help you maximize the value of your business.

Asset turnover measures the speed at which each system produces sales equal to the value of the assets used to generate them. In agriculture, asset turnover moves slowly because you cannot speed up the production processes. This under-utilization of resources leads to a low asset turnover ratio.

The DuPont equation also looks at net profit margin. Comparing profits against gross sales allows you to examine profit efficiency.

Leverage is very important when maximizing the value of the business. The more you own of your dairy farm (equity), the lower the ROE will be for a given amount of net income. Debt can be the greatest fear of some dairy producers. However, removing all of the debt may not be the most profitable option. Sometimes you can increase profits by using leverage to grow a business that is well managed and profitable.

If a dairy has a high ROA and ROE, then using a bank's money can increase profits much faster than only using cash generated from the business. When debt is employed, it must increase assets in order to grow the business. If a dairy has an annual 25 percent ROA, and money can be borrowed at 10 percent, the farm can experience a 15 percent return on the bank's money. But, be careful, you must know your financial and production management capabilities in order to increase profit with debt.

Many dairy producers find themselves under-leveraged for the amount of equity they have acquired. However, a profitable producer should weigh the use of additional debt to leverage the business into a larger, more profitable position.

The DuPont model allows you to measure the long-term production and financial performance of a dairy enterprise. It will allow higher profits to those who utilize its calculations to evaluate, change, and implement new strategies that correct financial and production deficiencies that limit profit.

Paul Johnson is a veterinarian and consultant in Enterprise, Ala.  



Comments (0) Leave a comment 

Name
e-Mail (required)
Location

Comment:

characters left


Grand L60 Series

Kubota’s Grand L60 Series combines a higher level of luxury with outstanding productivity never before seen in this class of ... Read More

View all Products in this segment

View All Buyers Guides

)
Feedback Form
Leads to Insight