When it comes to managing profitability, it’s natural for dairy producers to focus on milk prices. But ignoring the expense side of the equation leaves you exposed to potential margin erosion. And when your margins are squeezed, your liquidity suffers, putting your cash flow at risk.

Nelson douglas
President of Business Banking Agriculture - BMO Harris Bank

Protecting your margins goes beyond paying attention to the revenue side of the ledger. Focusing on these three categories can help put dairy producers on the right track:

  • Knowing your cost of production. This is the first step toward margin management.
  • Tracking input costs. Feed, fertilizer and fuel are typically the most volatile costs.
  • Managing your interest rate expense. It’s crucial to know what your exposure is to fixed-rate versus variable-rate debt. In a rising interest rate environment, high exposure to variable-rate debt can lead to margin erosion.

Focusing on these areas provides a more complete view of your income statement as opposed to just managing the top line. Frequently, many dairy producers focus on milk prices because it’s the easier metric to measure and manage. Producers will typically employ hedging strategies around the revenue side of the business as opposed to revenue-plus-expense side.

To be fair, when producers get their monthly report card, it’s more difficult to determine the monthly cost of production unless they have a robust accounting system in place. Also, producers believe they can more easily measure and influence production and quality, which immediately improve their milk check.

Know what you can control

You have to focus on the top line and the expense line to get to the bottom line. How? By establishing a dashboard to determine the variables that have the most impact on your margins. At a basic level, your dashboard should include the following:

  • Revenue side: Price x milk output (volume, components, quality)
  • Expense side: The three to four main variables that will drive margins (e.g., feed, fuel, labor, interest rate expense)

On the revenue side, some of the output factors you should consider include herd pregnancy rate, age of herd and cull rate. What you list with expenses will depend on your unique situation. If you’re growing a substantial portion of your feed, for example, crop inputs will be one of those variables.

Labor is another big expense, one that’s difficult to control because the current trend is toward increasing labor costs. Knowing that higher labor costs will compress your margins means you have to put more focus on the expenses you can control.

After you create your dashboard to get a view of where you stand, your buyers and vendors may offer programs that can allow you to take advantage of current prices into the future. Third-party nutritionists, marketing consultants and crop consultants can also help you develop hedging strategies. For interest rate protection, a conversation with your banker can help determine your best strategy in a rising rate environment.

Also, a dashboard isn’t a one-time exercise. It requires periodic monitoring and readjusting, whether monthly, quarterly or annually. Reviewing your dashboard as part of your regular meetings with your banker is a good practice.

Mitigating your risks

If you protect only on the revenue side, you’re leaving your operation subject to the vagaries of the market. Your expenses can spike dramatically, leading to major margin erosion. On the flip side, looking only at expenses and not income can have the same adverse impact.

The particulars of each operation’s dashboard will be unique, but regardless of your operation’s size, you can calculate your cost of production, know your revenues and expenses, calculate your margin and establish a dashboard with which you can manage and adjust your strategies as necessary.  end mark

For more agriculture industry insights, visit the BMO Harris Bank website.

Douglas Nelson