Information and tools available for dairy farm business mangement.
Managing risk in a dairy business environment
In this section the follow topics will be discussed:
What if?
The simple way to understand the risk environment that a dairy farm faces is to think of the question - What If?
When you complete a projected cash flow or budget there is always a probability that your estimate of income and expenditure will be incorrect. This could result in your projected surplus not being realised. You may in fact incur a large deficit. We have risk because we can't make perfect forecasts. This is true whether we have normal seasons or drought.
It is important to note the impact of the following in planning.
Risk factors
These may be both internal and external to your farming operation, some can be controlled while other risk factors you have no control over. Risk factors can be classified as follows:
Business risk - defined as risk associated with the physical operation of a dairy farm.
What if the seasonal conditions are below average, what if labour efficiency suffers maybe through an accident or the loss of a key staff member, what if my irrigation allocation is reduced by 20%, what if production per cow is 500 litres below target or the number of lactations is reduced by 10 percent?
Financial risk - risk associated with movements in input costs and output returns.
What if the projected milk price falls, what if grain prices increase, what if interest rates rise, what if banks tighten overdraft or borrowing rules?
Economic risk - this is a risk over which you have little or no control.
What is the impact of government policy and decisions on your farm and the dairy industry in general? What is the impact of rising inflation, declining consumer demand caused by new taxes or a substitute product entering the marketplace?
It is essential to quantify each risk factor independently and also check the impact on our business when more than one risk factor is varied.
What if production per cow changes 5% or 10%, what if production fell 5% and grain prices rose by $100 per tonne?
Shown below is a simple sensitivity analysis exercise. The projected gross margin was $164 730. The table shows the variation if returns and variable costs fluctuate from 0 to +/-10%.
By understanding the above discussion, the business operator now has some knowledge of the impact of changing scenarios. Spreadsheets are an ideal tool for this analysis. Managing risk is not complete unless the manager formulates a strategy to deal with these events before they happen. As an event appears imminent, then you will have the confidence to change.
Wouldn't it be good to turn back the clock to April 2002 if you had the knowledge and experience of the last 9 months? What would you do differently?
Consider this example where milk returns 32 c/L, you are feeding 5 kgs per cow per day and the response to feeding is 1.2 litres per kg fed.
There are many reasons why concentrates should form an important part of the daily diet. These include, minimising weight loss, to boost energy for milk protein synthesis to increase the farm-stocking rate and to balance the ration.
The strategy has to be - what supplement to feed, how much, what is the grain purchasing policy for the farm.
Positioning your business
Knowing how to position your business in the risk environment will depend on what your risk preference or attitude to risk is - is your attitude - conservative, moderate or aggressive. When investing, financial planners have detailed questionaries to determine a client's risk preference.
Questions, which help define the answer, are:
- Where is your business placed on the business lifecycle?
- Is it a rapid build up phase?
- Is it mature, is it declining?
- What is your current debt level?
- When do you want to retire?
- How long do you think the changed conditions will persist for, 3,6 or 12 months will also affect your response?
- How accurate is the information you rely on to form opinions is also of importance.
Your farming experience in similar conditions is invaluable as is your faith in climate and grain industry predictions.
Where should the focus be now?
4 business traits
A good place to start is by reviewing the four business traits:
- Liquidity
- Solvency
- Profitability,and
- Efficiency.
Liquidity
The golden rule of business is to maintain liquidity - paying your debts as they fall due, this ensures you maintain your credit rating with financiers and suppliers.
Generally this implies that each month all accounts are paid. This can be from monthly milk or cattle sales or from an overdraft facility. A longer term view accepted by many farmers is that the debt owed should be no larger than the value of plant and stock ie items that can be traded quickly. On the average dairy this would be about 25% of the total asset value.
In QDAS we use two other indicators to review liquidity; (i) the percentage of milk income spent of debt repayments (benchmark <20% of gross milk income), and (ii) the interest paid per cow (benchmark <$200 per cow). If interest rates rise or overdraft is increased both these measures will show an upward trend.
Solvency
Maintaining equity (%) and net worth ($), is another priority. Realistically cattle and land prices may fall in a drought. Again some averaging may be required. The question to be answered is - How far are you prepared to let your net worth decrease, without a major strategic decision being implemented?
Below is an example of how net worth may change due to an $85 000 overdraft increase.
Note - The owners net worth declines significantly by $85 000 to $185 000. The assumption is made that the overdraft is used to purchase operating items (eg feed) not an asset (eg feed wagon).
If I convert this overdraft extension to a medium term loan (say 5 years) then possible tloan repayments are as follows, (assume 8% interest).
Profitability
While return on assets and equity is always a major target, in drought times it may not be possible. In these calculations non-cash items, depreciation and an unpaid labour allowance is included.
A more realistic view is probably to use a three-year rolling average as fluctuations are then smoothed out.Efficiency
Two key performance indicators of interest under the efficiency traits are: What production per cow (production per cow has a significant effect on gross margin R=0.24) will I target and what feed cost would be appropriate (feed costs account for up to 45% of gross milk income in normal years)?
To consider production per cow I would like to know the breakeven farm production in annual or monthly litres required. This will then assist in positioning the production side of the business:
- the number of lactations (cows to be milked)
- production per cow (litres), and
- the return per litre expected.
Under this efficiency trait I am prepared to consider - appropriate lactation length eg 250 days or the normal 300 days and drying off production yields.
When you have a strategy for milk production then formulate a heifer management strategy. There are many possibilities including, no change, selling into lucrative overseas markets, reducing numbers through local sales or agisting heifers.
The next major step and the one that most farmers feel more comfortable with is formulating the feeding strategy. It must however address a wide range of issues:
- a home grown feed plan - crops, areas, irrigation and fertiliser strategies, possible yields etc, and
- a purchased feed plan - what supplements, how much to feed, how long to feed etc.
Information about different feeding systems can be found in the M5 Information Series
A process that could be adopted to assess change
- Review the current farm production and financial data - conduct a gap analysis to determine strengths and weaknesses of the present operation.
- Set preliminary goals and objectives
- Test scenarios
- Based on the best scenario/s develop a cashflow budget (1-3 years)
- Develop a capital/asset budget for the proposed change
- Complete a loan schedule/debt management plan
- Conduct a detailed project analysis based on the above facts and figures (8-10 years). This analysis compares the present operation with the 'new' operation to determine the critical success factors and the return on the new investment
- Conduct risk assessment
Important considerations
The following phases should be noted when thinking of expansion:
- If you want a better lifestyle you need to make a bigger profit
- Know your business before you expand benchmarking and gap analysis are essential
- Go slow in planning and be sure of the numbers
- Optimisation is more important than maximisation
Gap analysis
Some critical points to review are:
Ray Murphy
Agri-Science Queensland, Toowoomba
Phone: 07 4688 1094
Email: Ray.Murphy@deedi.qld.gov.au
© The State of Queensland, Department of Primary Industries, 2008