It’s a great problem to have, and one many dairy producers haven't experienced for some time: margins in the black.
As year-end rolls around, it’s important to make the best of a good year, and use existing capital to prepare for the future. “The worst year has a similar impact on your business as the best year,” said Greg Bethard, chief financial officer for Pagel’s Ponderosa and Dairy Dreams, Kewaunee, Wis. “It’s important to keep things in shape through the down years, so you will be in a position to reap the benefits of the good ones.” Conversely, a profitable year like 2014 can help weather cyclical downturns ahead.
Know your numbers
Bethard, who until recently was a dairy nutrition and management consultant, said the single best way to improve profits is to use available capital to sell more milk – at the same or lower cost per hundredweight.
To get a handle on those costs, he advises classifying expenses in three accounting “buckets” – feed cost per hundredweight (cwt.), labor cost per cwt., and replacement cost per cwt. “When you know those numbers, you can deliberately work to lower them.” For example, he said labor cost is a volume-driven figure that is too high on many dairies. If that figure is beyond $1.25 to $1.50 per cwt., you should be looking at on-farm investments to either lower labor costs, or sell more milk with the same amount of labor.
Identifying a dairy’s bottlenecks to greater profitability should be a team effort, according to Greg Steele, lending specialist with AgStar Financial Services, Baldwin, Wis.
“This is an excellent time for dairy managers to sit down together with the dairy’s team of key advisors – the nutritionist, veterinarian, breeding specialist, lender and business consultant – to identify opportunities to increase production,” he suggested.
“Could improvements be put in place to improve death loss, culling rate, animal health, feed costs, cow comfort, reproduction, or something else?” Then, the team can work together to allocate resources to overcome that primary hurdle.
Pay down versus buy up
Choosing between debt service/equity building and reinvestment is a personal decision. Bethard noted that higher levels of equity actually have a negative effect on return-on-investment (ROI). But high equity equals less risk in a down market. As a rule, he likes to see dairies with enough equity (not cash on hand, but total equity) to cover a $3.00/cwt. loss in milk income for an entire year.
Steele uses a guideline of retaining liquid assets (cash on hand) of $500 per cow. “In years like 2009, we saw how quickly capital can erode off a balance sheet,” he said. In terms of equity, he noted, “Some dairies operate routinely at 40% equity, while others prefer to be in the 50%-60% range. It’s an individual strategy based on operational objectives and risk tolerance.” He stresses budget forecasting, based on historical performance of the business. “Once you have a handle on cost of production and balance sheet figures, you can learn a lot by tracking those numbers over time.”
The tax man cometh
The desire to avoid taxes is a natural inclination, but Steele prefers tax “management,” because avoidance often simply kicks the can down the road. “Making financial decisions based solely on tax avoidance can really paint you in a corner financially in the future,” he said. However, leveraging opportunities like equipment deductions via Section 179 in the tax code (see “Section 179 limit extension still in limbo”) can have tremendous value.
Prepaying for inputs like crop expenses, fuel, parlor chemicals, feed, semen and other necessary purchases is a common strategy that is most valuable when accompanied with discounts. You even may explore some creative strategies to prepay services like custom heifer-rearing costs and veterinary fees. Pre-paying Margin Protection Program for Dairy (MPP-Dairy) policy premiums is tax-deductible, he added.
Bethard cautioned there are IRS-mandated limits to prepayments, and your ability to utilize prepay strategies may be impacted by whether you use the cash or accrual accounting method. Always be sure to secure thorough documentation of prepayments, and only prepay with financially stable, trusted vendors.
What are people buying?
Steele said he is seeing producers making mostly strategic, incremental changes to increase production, versus large, whole-scale projects like facilities construction. Those business-enhancing investments include:
- LAND. With prices tempering a bit in many places, land can be a good investment, securing a base for feed production and nutrient application. Steele cautioned, though, to be sure the price does not tie the dairy to high cost of production long term. Historically, ROI on land has run about 4% to 6% per year for dairy enterprises.
- FEEDING EQUIPMENT. “Inefficiencies in feeding systems are extremely expensive,” said Bethard. That’s why he sees TMR wagons, pay loaders, facers, feeding software, scales and feed-storage facilities all as excellent investments, particularly if they help minimize shrink and feed waste. This is a good time to work to rebuild feed inventories in anticipation of potentially leaner periods ahead, Steele said. Automated calf-feeding systems also are of high interest to many producers.
- MANURE-HANDLING EQUIPMENT. Investing in new and more efficient ways to manage manure can cut labor costs and/or better position a dairy for future expansion, said Bethard.
- GENETICS. Steele sees more producers embracing genomics and accompanying strategies like embryo transfer to make genetic progress. “Genomic testing is one of those technologies that really took off when milk prices got better and producers felt as if they could afford to try it,” he said.
- ROBOTIC MILKING SYSTEMS. Bethard said he hears more producers enquiring about robotic milking than ever, but the systems currently are more advantageous from a labor management standpoint than a strict enhancement to the bottom line. “The herds that will realize the best milk-production return from robots, and dilute the cost of the investment, are the 2X-milking herds,” he stated. “But in terms of basic labor costs, the numbers don’t change very much, and the up-front investment can be steep.”
Regardless of what financial decisions you ultimately make, always be mindful of the future, Steele said. “The ultimate goal for every financial decision should be to positively impact net return and long-term sustainability for the business,” he said. Also, don’t forget to fully fund retirement savings vehicles to traditional, SEP, SIMPLE or Roth IRAs to diversify your personal assets.
Finally, neither advisor quarrels with the idea of taking a nice vacation or doing some desired home improvements, provided they don’t upset the overall balance sheet. “There’s nothing wrong with embracing quality of life and celebrating a successful business,” said Bethard. “It’s what we all strive for. Don’t feel guilty about enjoying it when you can.”
Editor’s note: The following article is from our November 2014 print edition. Read the entire edition when it’s live online at http://www.dairyherd.com/dairyherd-issue-archives/.