Accounting for profits: Be honest

“As the industry finds itself in a very distressed financial condition, the one piece of advice I try to give each client is to be honest. Be honest with yourself, your family, your partners, vendors and banker…and acknowledge your current situation…”


By Bob Matlick

“Hindsight vision” is always 20-20, that is the way history has always been. After grappling with low milk prices and high input costs for more than a year, with what can we look back at and educate ourselves?

Risk vs. reward

When dairymen expanded, purchased more farm ground, built a new parlor or bought the neighbors dairy, did they understand the risk in expending the capital and management resources? As I look back into mid 2007 and early 2008 I can see many purchases and/or expansions that were made with little consideration for the risk involved. After all milk prices within the high teens that bounced over $20 for brief periods of time made for great projections.

‘Blinders on tight’

The export markets were booming and we strapped our blinders on tight. Milk prices had entered into a new dimension and there was no looking back. Cash flow projections (if they were even completed) laid out milk prices in the $18-$22 per cwt. range with little regard for a pull back into the historical range of $12 per cwt. and no regard for historical lows in the $10 per cwt. range. We all, dairy farmers, bankers, business consultants, feed vendors, etc., got caught drinking the Kool-Aid.

Then the world economy tanked, exports dried up, feed prices skyrocketed coupled with the huge spikes in energy and suddenly the monthly cash flow deficits were huge on dairy farms. The “Perfect Storm.” Equity was not just eroded, but eaten away in huge chunks to the extent some operations became unbankable. Had we considered the risk versus the reward?

Lessons learned

What did we learn with our 20-20 vision?

While milk prices were at all time highs and poised to go higher we neglected to look at any downside risk. Very few cash flow projections looked at scenarios with milk price at $12 per cwt. and even fewer considered feed prices at $6.50 per milking cow per day. Bankers became very competitive, giving little consideration to equity and leverage, while primarily looking at cash flow scenarios projected with all time high milk prices and low feed prices.

Dairy producers in most parts refused to look at margin management and ignored the milk futures market thinking $20 per cwt. is great, but $25 per cwt. will be better.

Driving prices

It is my belief the industry did not fully understand the tight supply-demand ratio that drives milk prices and did not understand the emerging global markets and the effect of the overall global economy. Perhaps few did have a full understanding and tried to communicate their warning, but most refused to believe. In hindsight, we just accepted the current thought process and did not recognize or protect downside risk which was huge and unfortunately has occurred.

Had the industry stepped back and recognized the potential downside risk, we may have been more cautious with expansion plans, the purchasing of additional assets (which may or may not had any significant return on investment) or paid down debt to improve equity positions. After all the potential to go to $12 per cwt. for an extended period of time was much greater than achieving $27 per cwt. History told us milk sold at $12 per cwt. at the farm level while we had no lengthy history of $22 per cwt. Hopefully going forward we will examine both the upside and downside risk and reward while managing that risk.

What now?

As the industry finds itself in a very distressed financial condition the one piece of advice I try to give each client is to be honest. Be honest with yourself, your family, your partners, vendors and banker.  Be honest with yourself and acknowledge your current situation, consult with professional advisors (attorneys, accountants and business consultants) if needed. Let your family know where the business stands while also acknowledging your fears with them. Communicate frequently and honestly with your vendors, and bankers, let them know you have identified the issue and how you intend to solve the problem(s). For example, prepare a realistic cash flow providing for repayment that will be updated and communicated frequently, partial or full liquidation plans or any major management changes that will assist the financial problem.

The bottom line is we need to learn from our mistakes, acknowledge that the dairy business is fraught with risk and continue to evaluate measure and manage each individuals risk and reward.

FYI

Bob Matlick, CPA, is a partner in the Agriculture Department  with Moore Stephens Wurth Frazer and Torbet, LLP,  in Visalia, Calif. Contact him by e-mail at: bmatlick@mswft.com or call, 559-732-7140.


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