Fit in 2022: 12 Financial Benchmarks to Help Manage Your Dairy’s Future
November 1, 2021
With a new year on the horizon, you might be thinking about personal goals. For many, fitness is a resolution to drop some pounds or improve blood pressure or cholesterol levels. However, financial experts strongly encourage producers to use the new year as a time to evaluate the financial health of your farm, too.
With costs going up for labor, feed and everything in between, knowing your numbers is key to helping your dairy plan for the future. The saying, ‘You can manage it, if you can measure it,’ especially holds true in terms of financial fitness. Carving out time to review the financial portfolio of your dairy operation needs to be a priority. Gary Sipiorski, independent agriculture business financial consultant, highly recommends producers review the following 12 benchmarks annually (if not quarterly) — and strive to reach each benchmark.
“These benchmarks are more important today than ever before,” Sipiorski says. “It’s not only important for you to know these numbers, but it also makes for good discussion with your lender, who uses many more ratios to assess your dairy’s financial performance.”
THE 12 FINANCIAL BENCHMARKS
1. Income Per Cow: $5,000
Generating income applies to every cow in the barn, including dry cows. To determine your average income per cow, divide the total gross income by the total number of cows on the farm, including dry cows. This income includes milk, cull cows and baby calves sold. Do not factor in income generated from other enterprises unrelated to milk sales, such as grain or steer sales.
2. Operating Expense as a Percentage of Gross Income: 60% to 80%
Take the Schedule F expenses minus interest and depreciation. Family living is generally not part of the Schedule F, but some family living costs should be added in. Then divide this number by the gross farm income. Make sure to take out any prepayments. If any expenses were carried over and not paid, such as payables, make sure to add them back in. Sipiorski suggests adding a “wear-and-tear number,” such as 10% of the machinery cost, to this figure.
3. Milk Sold Per Cow: 80 lb. for Holstein
Higher debt loads are better serviced with more hundredweights sold. This can be adjusted for other breeds. Jerseys should be around 65 lb. of milk/cow.
4. Ownership Equity: At least 50%
This represents the percentage of the farm you own and is determined by subtracting the liabilities from assets. After completing the farm’s balance sheet, the ownership equity is then divided by the total assets on the balance sheet. This determines your ownership equity. In a money-stressed year, it will be difficult to go to a lender to borrow additional money when equity is below 30%.
5. Current Equity Ratio: $2 Current Assets for Each $1 of Current Liabilities
This ratio illustrates the ability to pay yearly operating bills. Current assets are cash, feed, money owed to you, market animals or items that will be turned into cash in the next 12 months. Current liabilities are bills over 30 days, past-due rents or taxes, lease payments and principal payments due in the next 12 months. During tough times, a 1.5:1 current ratio is acceptable.
6. Cost of Producing 100 lb. of Milk: $17.00
See the expenses used in item #2 above, add in interest and depreciation and then divide those expenses by every 100 lb. of milk sold during the year. A good target is $17; however, the bottom line is you need to produce milk for less than you sell it for. This number is adjusted for colored breeds.
7. Feed Costs: 20% to 45% of the Gross Income
The variation of the range depends on how much feed you produce yourself. If you purchase all your feed, your feed cost will be around 45% of the milk check. Feed is the biggest cost to a dairy and each farm needs to individually evaluate depending on variables such as needs and forage quality.
8. Livestock Expenses: 4%
The expenses in this area are breeding and herd health costs only. Of course, if a dairy performs IVF or ET work, the percentage will be higher than 4%.
9. Debt per Cow: $3,000 to $5,000
Debt per cow will depend on the farm’s repayment ability and terms of the amortizations of the loan. Some farms can manage as high as $7,000 to $10,000 debt per cow. This is a lender/producer discussion and decision. Sipiorski says it is OK to borrow money as long as you do it for the right purposes.
10. Debt Coverage: Less than 20% of the Gross Income
This represents the amount of interest, principal or lease payments to be paid divided by the farm’s gross income. As new assets are added into the farm and money is borrowed, the life of the asset should match the amortization schedule.
11. Asset Turnover: 3
The average U.S. farm turns assets every 4 years. “That is too long,” Sipiorski says. “The farm either has too many assets or it’s not generating enough income.” Think about this the next time you buy something. How will it affect asset turnover? For every $1 million of assets on your farm you need to generate $333,000 of gross income. This would give you an asset turnover every 3 years.
12. Total Investment per Cow: $8,000 to $20,000
This number relates closely to asset turnover. Sipiorski says to make sure assets used in this calculation are dairy cow related (cattle, building, land and machinery used for the milk cows). If you have other enterprises, such as grain production, those assets need to stay out of this calculation. A dairy farm needs a lot of capital, but you should have limits to stay competitive with other milking herds.
BECOME A ‘FINANCIALLY FIT’ FARM
According to Sipiorski, the top 30% of dairy producers in the U.S. earn $1.25 per cwt. more versus the average producer. “This is a good time to get your financials together,” he states. “You can’t plant corn tomorrow and you’re going to need all your numbers in line not only for your accountant, but for your knowledge to help you know your profitability.”
To become a financially fit dairy, experts say producers need to look at a longer-term plan, rather than the day-to-day plan. “That $1.25 can add up to a significant amount over time,” Sipiorski remarks.
According to Virginia Tech professor emeritus, Dr. David Kohl, today’s producers generally fall into three buckets. Forty percent will grow incrementally because they have working capital, equity, profitability, cash flow, proactively approach problems and have a high business IQ.
“Another 40% will be able to hang on but won’t thrive because they’re limited by their ‘low business IQ,’ which will result in profit and cash flow issues,” he says. “These producers will probably need to refinance to survive. Then there’s the remaining 20%. These farmers will likely need to have a partial or total liquidation because they are not in the position to be profitable and to cash flow, and often they drain working capital and equity.”
Both Sipiorski and Kohl encourage producers to pull out the previous year’s income statements and balance sheets if they haven’t already. Next, get the numbers as accurate as possible, so you can compare year-over-year profit and net worth values. Be aware 2020 included a great deal of government income. Consider that as you plan for 2022.
After you get your figures up to date, revise a written business plan based on a true accrual income statement. “Only 20% of dairy farmers do this,” Sipiorski says.
Kohl says business and management IQ can make a difference for a farm. He also underscores the importance of producers zeroing in on their management mindset, which he says is very critical in putting their odds in their favor.
“A proactive attitude is critical in executing and monitoring specific management strategies for overall success,” he remarks.
Suze Orman, financial adviser and author, once said, “No one ever achieved fitness with a January resolution that’s abandoned by February.”
Set yourself up for success the new year and make financial fitness not only a resolution but a goal to help position your operation to end 2022 with a healthier financial portfolio.