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Managing the cycles: Staying in control of your dairy business

June 3, 2014 | 0 comments


Like spring and winter, sunshine and stars, cycles are the canvas for a dairyman's life and business.

Besides the familiar seasonal mini cycles, Dr. David Kohl points out there are macro economic cycles of 40-60 years, business cycles of 20-40 years, and agriculture economic cycles of 2-10 years.

The ag cycles are in extremes, Kohl said during "Managing Through The Cycles: Staying In Control of Your Business", a World Class Webinar presented by Professional Dairy Producers of Wisconsin. "It's one year up and the next year down; so unpredictable."

According to Kohl, president of AgriVisions and professor emeritus of agriculture and applied economics at Virginia Tech, the cycle situation will create more opportunity in the next 5-7 years than in the past 30 years. It will also create more opportunity to fail. "You better get used to managing through cycles," he advised.

Views from the road

Kohl referenced data gathered on how dairy producers use measurements in their decision-making. While 28 percent of producers are obsessive about measurements and use them in planning and decision-making, "the scary part" is the 54 percent of producers who measure many things, but do not use the information in their decision-making or to improve their farm.

"That's complacency," Kohl said, observing it is very easy to get away from the basics during up times in the cycle.

Of even greater concern is the 18 percent of dairy producers who track just enough to get by, mainly for taxes and crop/livestock yields.

"This is a hard, cold fact. Of those 72 percent of producers, about half will be in financial jeopardy, particularly in the down part of the cycle," Kohl said, while the other half will make adjustments to survive. "Complacency kills in business, and it is out there in agriculture."

Fifteen or 20 years ago when there was $2 variations in milk price and little in feed costs, a dairyman could get by, but not nowadays with $12 variations in milk price and feed costs bouncing all over the board. "That type of financial strategy will get you in trouble every time, particularly if you don't have financial shock absorbers," Kohl said.

Top of the cycle characteristics and strategy

The dairy industry is riding high. Milk prices are strong, feed costs are moderating, fertilizer costs have come down, and interest rates are low. "We are definitely in the top of the cycle," Kohl said, with expectations, exports and trade with China bringing the markets to a boil.

What should a dairy producer's strategies be? To start with, pay all expenses and get payables current. "This is the time to get your balance sheet and income statement in order," Kohl said. "If you aren't paying all expenses and have payables current now, you have a problem."

Build working capital (current assets minus current liabilities) to 33 percent of revenue or expenses. "Your goal should be to self finance, if you had to, at least a third of your operating expenses," Kohl explained.

Dairies that are heavily financially leveraged with percent equity between 33-50 percent, as many larger dairies are, should build their working capital toward 50 percent of revenue. "You aren't going to be able to fall back on your equity, so that's your shock absorber," Kohl explained. "I can tell you right up front, many of the lenders that I train and teach are really emphasizing this working capital area."

Time will tell whether dairy producers have the required discipline or will they, instead, plow all their profits into growth, he noted.

Dairy producers should also have one year of debt service covered with cash in the bank and enough cash for 1-3 months of expenses. "I know a lot of you are shaking your head east and west on this, but I would tell you, in the top of the cycle, to build up your cash. This is your shock absorber," Kohl explained.

Building up cash should be a high priority. "I hope you will discuss with your lender, set up and have a review of your financials to make sure you have this," Kohl said.

Plan for profits. "A lot of you are going to make a lot of money this year because of the economic dynamics. Make sure you have a profit plan," Kohl said.

He advises putting 60 percent of profits into efficiency and growth. Find ways to become efficient in production, in marketing, in finance and the overall operation of the dairy. "Once you get that, then you can look at growing," he said.

Allocate 30 percent of profits toward the financial shock absorber of working capital, then enjoy the remaining 10 percent. But beware of extravagances, like lake houses and exotic trips that swallow unhealthy amounts of farm profits. "That is a killer at the top of the cycle and I hope many dairymen don't get caught in this trap," Kohl said.

The top of the cycle is also a good time to upgrade farm personnel and shed subpar employees who feel they're entitled. "Sometimes, that means members of the family, but unfortunately, the situation looks so good at the top of the cycle that, often, that's when we bring them on," Kohl observed.

Bottom of the cycle characteristics and strategies

The view from the bottom of a cycle is weak milk prices, high feed costs, high crop and fertilizer costs, and an increase in interest rates of 2-4 percent. "If we get all four of those, we absolutely could see a repeat of 2009," Kohl warned.

At this stage of the cycle, dairymen are simply trying to break even. "Realize that coming off times when you made a lot of money to times when you just breakeven can really hurt you — owners, management team and everyone involved, psychologically," Kohl said.

The dairy will burn through its working capital, but try to keep it at 10 percent of expenses or revenue. For heavily financially leveraged farms (33-50 percent), try to keep working capital depletion to 20 percent of revenue. "When you start dropping below those levels, things are beginning to look a little bit critical," Kohl said.

Likely, the farm will not be able to keep more than six months debt service payments cash in the bank and have banked cash to cover more than one month's expenses. "This is staying in control of your business. This is basically giving you the boundaries to be able to operate and manage your business from a financial standpoint.

When times get rough with low milk prices and high feed costs, a lot of dairymen throw up their hands, Kohl said, but knowing the break points and critical elements will help you maintain control of your business.

Try to maintain a positive cash flow and know your burn rate on financial liquidity and working capital by sitting down with your lender to determine them. "This is a powerful analysis. It tells you how strong your shock absorber is," Kohl said.

Lenders will be keeping their eye on accounts payables, so try to keep it under 5 percent of revenue, he advised. Problems develop when it gets over 20 percent.

Keep capital expenses to a minimum. Realize that thinning margins mean you'll be lucky to be able to pay down your operating loans about every 12-18 months, Kohl added.

Facing reality

"This is the realities at the top and the bottom part of the cycle," Kohl concluded. "Oft times, when we're in the top of the cycle, everybody looks at growth, growth and more growth. People get outside of these aspects."

Volatility in the market will not lessen, Kohl said. If anything, it will increase due to the deeply psychological aspect of markets and the trillions of global "hot money" that loves to play the commodity markets.

In addition, increasing regulations in Europe, Japan and the U.S. will force dairy growth into emerging, more unstable countries. Kohl is "very, very concerned" that agriculture and dairy could become like oil in the 70s, 80s and 90s.

"With this volatility, we've seen nothing yet and she's going to continue to increase," he predicted.

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