In an ever-changing industry, you never know when feed costs will soar and milk prices will fall.
“All you can do is be prepared for challenging times,” explains Lonnie Wells, an associate from the Russell Consulting Group of Panora, Iowa.
A breakout session presenter at the 2015 Pennsylvania Dairy Summit, Wells outlined tips and plans to achieve long-term success on dairy farms. Throughout the discussion, Wells focused on the importance of a well managed and up-to-date balance sheet that encompasses all aspects of the operation in order to accurately manage financials.
Wells encourages producers to “bulletproof” their balance sheets.
“Producers must establish financial goals and position the business so that it can remain viable in challenging times,” he said. However, once a goal is defined, producers must commit to the goal and discipline themselves and their finances in order to achieve success.
Before setting any goals, be aware of your surroundings. Utilize resources to obtain a complete financial analysis of your current operation and identify your weaknesses. Once you know your current financial state, you can set goals and objectives for a business plan.
To minimize financial stress, producers must maintain a strong balance sheet and stay in line with the financial targets established by the industry.
Working capital = 50 percent or more of annual expenses
- Working capital is a measure of farm liquidity. Total current farm liabilities are subtracted from total current farm assets to find working capital. This measures the ability of the farm to pay off current liabilities.
Owner’s equity = 50 percent or more
- Owner’s equity is the legal entity of the business. If the percentage drops below 50 percent, the bank will be the majority stakeholder in the farm and will have more impact on business decisions.
Return on assets = 6 percent or greater
- Return on assets is a measure of the farm’s profitability and can be calculated by dividing the earnings of the fiscal year by the total assets.
Return on equity = 16 percent or higher
- Return on equity measures the business’s profitability. This percentage indicates how much profit is generated from each dollar of the shareholder’s equity.
Expense-to-revenue ratio = less than 65 percent
- If the operation can’t achieve an expense-to-revenue ratio of less than 65 percent, then the producer must reevaluate current farming practices. Efficiency will be key in reducing this ratio.
Family withdrawal = less than 10 percent
- The family withdrawal as a percent of revenue should be less than 10 percent. If records indicate the withdrawal is greater than 10 percent, the operation must reevaluate how many individuals are making a living from the farm’s income.
Producers are advised to routinely calculate these ratios and compare the values to industry benchmarks. By knowing financial standings, producers will make more appropriate cost management decisions. In addition to cost management, producers must also be proactive in controlling other risks.
It is important to be aware of risks and the probability that your operation will be affected. Producers can transfer the cost of an undesirable outcome to insurance companies. By purchasing insurance and locking in prices for milk and feed, producers can reduce the impacts of such events as accidents, natural disasters, low revenues and increased operating expenses.
Producers are tasked with an uncountable number of responsibilities in an agricultural business. Wells described farmers as having five critical tasks: “You are a plant and production manager, a financial manager, marketing manager, risk manager and a human resource manager.” Because few producers can be successful with all five tasks, Wells encourages producers to take advantage of consultants and advisers.
A resourceful producer who accepts advice from key consultants and advisers can work toward a “bulletproof” balance sheet for a successful, progressive dairy operation. PD
Sara Kitchen is a Penn State student and a freelance writer based in State College, Pennsylvania.
Illustration by Kevin Brown.