“The world has a habit of making room for the man who has a plan, knows where he is going, and then takes steps to reach his desired destination.” — Basil Walsh, author
By John Ellsworth
In my last article, I noted that the dairy industry is in some very difficult times. Writing this article in mid-March, I’m hopeful there will be some relief on milk prices by summer. Class III futures are increasing and are presently over $15/cwt. starting in October. This is a good time to be asking: What will it take for my dairy business to survive? What steps will I need to take to ensure future success? While these are always a great questions to ask, there has never been a more ideal time to consider them than now.
What is your return on assets (net income/total assets)? How are you doing on return on investment (net income/net worth)? These should be 10% and 15%, respectively. While these are just two benchmarks to consider, they represent your best measures of profitability.
Another important measure is your debt service coverage ratio. This is determined by dividing your net cash flow (net income + depreciation) by your current portion of long term debt (CPLTD).
CPLTD is the amount of principal you are required to pay annually on your term loans. This includes the principal payments made each year for real estate, herd, equipment and vehicle loans. Most banks want this ratio to be at least 1.25, leaving you a 25% margin of cash flow over the amount of principal you must repay each year. However, I have seen banks lower this to 1.10 when cash flow is tight.
The best three measures of liquidity are working capital, debt to net worth, and term debt/cow. Working capital equals your current assets (checking account balance, milk A/R’s, feed inventory, and investment in crops) minus your current liabilities (accounts payable, feed & crop lines of credit, the CPLTD mentioned above, and any other short term liabilities you may have). You want this number to be positive and the larger it is, the more liquidity your business has. Strong liquidity is positive since it enables you to weather downturns.
Debt/cow (total term loans/number of cows) and debt to net worth (total liabilities/net worth) are measures of how much debt your business is carrying. Of course, less debt is usually better. However, it actually depends upon how your debt load is structured. If your debt consists mostly of long term (20 to 25 years) real estate loans, you will be positioned to handle a higher debt load per cow than someone who has their term debt on a seven-year herd loan or on five-year equipment loans.
Rather than using an absolute debt/cow figure, look at your trend over the past five years. Is your leverage increasing because you’ve lost money and have had to borrow more? Or is it higher because you remodeled your milking barn to improve your efficiencies, such as cows milked/hour?
Speaking of efficiency, look at your pounds of milk per cow. Are you more or less efficient than others in your area? How do you compare on cows per full-time employee? Is your daily milk shipped increasing? All of these factors impact your costs per cwt. and are important.
While there are many measures to use in evaluating the success levels of your dairy operation, these are some you can use regularly to check your progress. Success, as with many things in life, is primarily a matter of knowing where you want to go, setting a plan and then measuring your progress toward those goals.