The dairy dozen: 12 key financial indicators (Part 2)
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 looked at the first six ratios in this Dairy Performance article. Now let’s look at the second half.
- Feed Cost: 20 to 45 percent of the gross income
This seems like a wide range, but depends on how much feed you produce on your own. In general, it takes 1.5 acres per cow to produce enough forage and 0.75 acres per cow to produce enough grain for the milking herd. Additionally, you need 0.75 acres per cow to produce forage for the youngstock. If you have this land available, the purchased feed cost should be around 20 percent of gross income. If you buy all feed, the cost will be 45 percent of the milk check. Any combination will run between these numbers. Exceeding 50 percent will put a strain on the checkbook. High feed cost years, like 2012, will hurt. Feed is the biggest cost to a dairy and each farm needs to evaluate individually, depending on variables such as needs and forage quality.
- Livestock expense: 4 percent
This is the “canary in the coal mine.” The expenses in this area are breeding and veterinarian costs only (items like rBST are supply expenses). If this number is higher, your dairy may have metabolic or other health issues. Hopefully, you catch the problems before generating your yearend numbers.
- Debt per cow: $5,000
Any herd can only service so much debt; $3,000 to $5,000 should be manageable, but $7,000 becomes difficult to service. The debt per cow will depend on the farm’s ability and terms of the amortizations. This is a lender/producer discussion and decision. Many lenders now calculate debt per 100 pounds of milk sold, which generally will be $20 per 100 pounds of milk sold per year.
- Debt coverage: Less than 20 percent of the gross income
This represents the amount of interest, principal or lease payments to be paid, divided by the farm’s gross income. A goal of 15 percent of the gross farm income should be manageable, with a maximum of 20 percent for years of lower milk prices. Exceeding 20 percent will make it hard to pay other bills.
- Asset turnover: 2.5 times
This ratio measures how many years it takes to turn the total farm assets, calculated by how much gross income is generated compared to total assets on the balance sheet. For example: A farm has $1,000,000 in farm assets and generates $400,000 in gross income. $1,000,000 divided by $400,000 means it takes 2.5 years to turn the assets.The average U.S. farm turns assets in 3.5 to 4 years. That is too long. 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?
- Total investment per cow: $7,500 to $15,000
This number relates closely to asset turnover. Divide the total assets by the total number of cows. A dairy farm needs a lot of capital, but you should have limits to stay competitive with others milking herds around the country and world. Make sure assets used in the calculation are dairy cow-related (cattle, buildings, land and machinery used for the milk cows). Grain and other enterprises do not put all the weight of the dairy cows. Keep those assets out of the calculation.
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