Managing cash flow with low prices

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The year 2000 brings financial challenges to dairy producers as market analysts predict low milk prices throughout the year. No doubt cash flows have begun to tighten on many dairy farms, and this year’s income will fall below the levels established in 1998 and 1999.

When cash flow tightens, your inclination may be to lower cost and avoid incurring debt. However, these tendencies do not always benefit your operation and can compound your financial situation inadvertently. When money is tight, producers run the risk of making mistakes.

Avoid input cuts
When milk prices fall, you may be tempted to make wholesale cuts in production inputs, hoping to drive your operating cost below the milk price. For example, you might consider a less expensive ration for the milking herd. However, while shifting to a “cheaper” ration reduces cost, it typically causes income to fall as well due to lower milk production.

What if cutting your feed cost by 10 cents per cow per day, saving roughly $37 per cow per year, resulted in a loss of 500 pounds of milk per cow per year? If the milk price averaged $12 per hundredweight for the year, the net loss would be $23 per cow per year ($60 - $37 = $23).

As a rule, cutting inputs such as feed, supplies, medicines, or bedding, will result in a loss of income.

Use credit
With a tight cash flow, you may be inclined to use cash reserves to purchase replacement cows, equipment, and other capital assets, instead of financing these purchases with a loan. This decision makes some sense in that it lets dairy producers avoid interest expense and principal payments on loans. But, the downside of this strategy is that it limits your cash reserves.

Committing large sums of cash reserves to the purchase of cows or equipment becomes risky if prices do not rebound. These reserves may be needed to purchase feed and other operating inputs later on. The lender is more likely to guarantee a loan with cash reserves in place. Therefore, producers should keep some cash in reserve to be sure that they have operating funds for any unforeseen problems.

Financing the purchase of capital assets over time makes good sense because it lets a producer keep 70 to 80 percent of the cash that would have been committed to the purchase of these durable assets.

Take advantage of discounts
Say a feed supplier offers you a 2 percent discount when you pay cash at the time of purchase. With low milk prices, producers often pass on this discount to conserve cash. And, even though they have an operating line of credit at the bank, they don’t access it. They don’t see how it could be cheaper to use borrowed money (with a 10 percent interest rate) in order to receive a 2 percent cash discount. However, in most cases, the gain from taking advantage of a cash discount exceeds the cost of borrowing the money.

Use the table below to help you decide when it’s advantageous to use borrowed money to receive a cash discount. The only cases where it appears to be inadvisable to borrow money to capture cash discounts is when the billing period is greater than 30 days and the discount is rather low.

Keep these common mistakes in mind. Doing so can help you make the best financial decisions during these low milk prices.

Bruce Jones is director of the Center for Dairy Profitability at the University of Wisconsin



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