Accounting for Profits: Can’t live in the moment
By Bob Matlick
Some would subscribe to the notion that we should all live “in the moment.” Unfortunately, with greater volatility and size of dairy operations in the United States, dairy farmers can no longer afford to live “in the moment.” They must plan ahead. Much like a jigsaw puzzle, these plans have many pieces which must work together to form a finished product.
Puzzle pieces
A dairy needs the following pieces to succeed going into the future:
• a rolling operating budget for the forthcoming 12 to 18 months.
• a crop budget for the farming operations for a full growing season.
• a risk management plan for both inputs and outputs.
• forecasted balance sheets and income statements.
• a succession or estate plan.
• a disaster plan.
While implementing these tools can be time-consuming, the rewards are usually very beneficial. Some benefits of these plans include more effective debt negotiation, capital improvement planning, expansion and diversification opportunities, and the ability to sleep at night.
A little closer detail of each plan or piece is discussed below.
Budget numbers essential
A rolling monthly operating budget or cash flow projection is essential on any dairy operation. The budget should be prepared on a monthly basis and extend into the future. The use of past financial statements is a good starting point. The budget should be updated each month with actual performance numbers. Using the budgeted and actual figures, variance reports should be generated. Additional updates should occur in the future months when new information becomes available. This includes items such as milk price, basis from Class III and Class IV CME prices, feed prices and/or contracts, confirmed pregnancies leading to projected milk and dry cows, and so forth.
Customize it
As you develop your own operating budget, you will find you can customize it with the appropriate income and expense drivers. This budget will also allow you to evaluate various options going forward.
For example, should the dairy continue to raise replacements, or purchase replacements? With available feedstuffs, should lower production be expected and/or managed? Capital improvements and major repairs should be included in the planning process, as well as all debt service and owner withdraws.
A crop budget should be separate from the dairy operating budget. While some may argue the cropping program is intertwined with the dairy (for example: labor, fuel, interest), it is advantageous to keep two entities separate from a cash flow standpoint. Allocations should be made to the best extent possible, and refined over time. A separate crop budget allows a producer to understand the true benefit of self-raised feedstuffs.
Risk management comes later
The risk management plan can be completed after the dairy and crop budgets are complete. Many producers use the services of a professional risk manager to assist in this area. The risk management plan should be developed and committed to writing after reviewing the cash flow. It should be updated as circumstances arise, and frequent communication with the risk manager should occur. The bottom line here is to make sure the use of risk management includes both inputs and outputs, and should not be utilized as a profit-making tool. Risk management should be viewed as way to minimize volatility, and a tool to meet dairy and crop budgets.
Forecasted income and balance sheets allow a producer to evaluate leverage and working capital positions. These can become useful tools in evaluating the amount of leverage a dairy may be able to withstand, working capital available for capital improvements in the future, and multi-year planning.
Succession, disaster plans key
Succession planning is key to every dairy producer. Does the producer intend to bring children and in-laws into the operation? If so, what terms and conditions are beneficial from a tax and operational standpoint? Questions of whether the business can support additional families need to be answered, as well as spelling out the intents of the older generation. Again, this planning needs to be done after looking at operational budgets and forecasts to determine the best opportunities for all involved.
Every business needs a disaster plan to cover unforeseen circumstances, such as matters relating to Mother Nature, the media, and injury or death to key employees and ownership.
When a dairy producer has completed the above planning procedures and shared them with lenders, financial advisors and risk managers, the puzzle becomes an organized picture. Without the proper pieces, the picture never develops and is at constant risk of spilling onto the floor into many jumbled pieces.
FYI
• Bob Matlick, partner, Frazer, LLP, Visalia, Calif. Contact him by e-mail at bmatlick@frazerllp.com or call, 559-732-4135, Ext. 107.
