The dairy dozen: 12 key financial indicators (Part 1)
Think about your last check-up at the doctor’s office. What questions did your doctor ask you? How did he or she determine you’re healthy or uncover any potential risks or problems?
Now it’s time for you to be the doctor for your farm’s finances. Pull out your balance sheet and cash flow records. Take a look at the following 12 ratios to determine your financial health. 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.
By achieving these 12 ratios, the others generally fall into place. We’ll take a look at the first six here; stay tuned to Dairy Performance for the second half.
- Income per cow: $5,000
Gross income must be generated regardless of the number of cows on your dairy farm. Items affecting income per cow include milk sales, cull cows, calf sales, government programs related to milk, and patronage refunds. Divide this number by the total number of cows on the farm, including dry cows. Although they may generate income, do not include other enterprises unrelated to milk sales, such as grain sales, steer sales, etc.
- Operating cost as a percentage of gross income: 80 percent
In 1980, a dairy farm’s operating expense rate was 50 percent. Today, due to inflation of expenses and the way milk is priced, the expense rate is generally 80 percent. A quick way to get this number is to use Schedule F on your tax return. Take the Schedule F expenses and add in family living. Then divide this number by the gross farm income. Make sure any prepayments are taken out. If any expenses were carried over and not paid, such as payables, make sure they are added in.It would be better to use the farm-generated records from the income and expense report. However, many farms may not have these systems whereas the tax return is readily available. If you want to find the “true cash cost of production,” add all of the cash expenses for the year, add principal and family living, and subtract the tax depreciation. Now you have the cost of production that comes out of the checkbook. You may want to add a “wear-and-tear number,” such as 10 percent of the machinery cost.
- Milk sold per cow: 24,000 pounds for Holsteins (adjust for other breeds)
In 1945, the average U.S. cow produced 5,000 pounds of milk. Better breeding, nutrition, cow comfort and management have raised the pounds of milk each year. Higher debt loads are better serviced with more hundredweights sold.
- Ownership equity: 50 percent
Ownership equity represents the percent of the farm you own. This is found on the balance sheet. It is determined by subtracting the liabilities from assets. That number is divided by the total assets. It should be 30 percent at minimum; more is always better. Borrowing money is not a bad thing in this business that requires a lot of capital. The cash flow must be able to repay the debt in a time period that matches the life of the asset. In a money-stressed year, it will be difficult to go to a lender to borrow additional money when equity is below 30 percent.
- Current equity: $2 for each $1 of current liabilities
This ratio shows the ability to pay yearly operating bills. It says, for each $1 needed, $2 is available to pay. Current assets are cash, feed, money owed to you, steers sales 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.
- Cost of producing 100 pounds of milk: $17.50
See the expenses used in item #2 and divide those expenses by 100 pounds of milk sold during the year. A good target is $17.50. Bottom line: You need to produce milk for less than you sell it. You need a margin.
About the author: Gary Sipiorski is the Vita Plus dairy development manager. He grew up on his family’s dairy farm in eastern Wisconsin and attended the University of Wisconsin-River Falls. Sipiorski spent 17 years with Citizens State Bank of Loyal and worked his way up to president and CEO. In 2008, he transitioned to his current role at Vita Plus and continues to serve on the CSB board of directors. In addition, he served on the advisory committee on agriculture and industry for the Federal Reserve Bank of Chicago. He is also an advisor for the Professional Dairy Producers of Wisconsin and a regular contributor to Hoard’s Dairyman and other agricultural publications.
Business and economics