Generally speaking, dairy producers are posting healthy margins right now. May milk prices were the highest on record, and 2022 prices are shaping up to be the highest ever, breaking the record set in 2014. But volatility in dairy markets is real, and margin compression could strike quickly. That’s why the decisions made during the good times are key to how you will do when the next downturn occurs.
So what can you do with the cash available after debt service? It starts with improving your working capital position. This could include the following tactics:
- Pay down accounts payable and double down by taking advantage of cash discounts. The cash discount helps to drive future profits while lowering cost of production.
- Pay down lines of credit. This reduces the interest you pay while building your borrowing capacity for the leaner times. This has taken on added importance since the Federal Reserve is raising short-term interest rates.
- Build a cash reserve. Maintaining a cash reserve not only gives you the ability to manage through low-margin periods with cash, it may also provide opportunities to take advantage of solid buying opportunities during the next downturn. Having available cash enables you to act quickly, and it has netted more than one of our clients a great buy on land or machinery. Essentially, being able to offer cash in a timely manner resulted in a significant discount to market values prior to the downturn.
- Prepay for items you’ll need in the future. This could include feed or fertilizer, especially if discounted pricing is available. The goal is to manage future costs of production while also preserving working capital in the future.
The goal with the latter three items is to have their total grow to more than $1,500 per cow during the good times so it doesn’t drop below $500 per cow in the bad times.
Take time to re-examine the business
When business is good and margins are strong, you’re in a better position to make decisions about the future of your operations. Manage capital expenditures with a focus on things that build efficiency and profit potential for the future. This could include:
- Labor efficiency investments. Employee costs are rising, so investing in either technology or other capital items that improve efficiency continues to be the focus of many top performers. We’re seeing increased parlor automation and herd monitoring software being deployed. We also see equipment sizing decisions to support labor efficiency, such as a larger mixer to reduce feeding times.
- Custom hires or investment decisions. We’re seeing more operations analyze the enterprises on the farm to determine which ones warrant further investment and which ones warrant outsourcing. For example, we’ve noticed a trend of investing in manure-handling equipment to support tighter windows of application, while heifer raising is increasingly outsourced. Sharpening your pencils and understanding your operations costs will be key to making the right decisions. To be truly thorough in this process, shock test your analysis to reflect what margins might look like in the future. The right decision at today’s margins may be the wrong decision when prices change. Be sure your modeling takes into account multiple scenarios.
- Examine your current investments in capital items. Some items that may not be necessary for your current operations may have extra value due to strong market conditions. Selling them now may make sense. This would also hold true for land base – trading faraway land for closer property may make sense.
Once you’ve met the goal of $1,500 per cow of cash, line availability and prepay balances, using available cash to limit additional term debt may be warranted. That is, making a larger down payme0nt on the capital item purchased than you normally would have to keep debt payments lower in the future.
Maintain sound cost control measures
Margins are better than they’ve been in several years, but costs are also going up. So now is not the time to loosen the reins and get sloppy with spending. The best managers keep a close watch on their cost of production all the time, not just when margins are tight. Doing 1% to 2% better in this area can significantly impact your operation’s ability to build working capital while developing a culture of cost controls that will continue to reap benefits in the tight margin periods.
While managing margins is critical during this time, it’s also critical to hone your risk management skills. Be proactive rather than reactive to the market conditions. Historically, the trip down the curve is much faster than the ride up. How long can you prolong the current strong margin period? Make sure you understand all the tools available and make sound, well-thought-out decisions to stretch out the cycle for your operation.
It’s also a good time to seek out the guidance of your trusted advisers. While it’s often natural to rely on them during the tough times, keeping the lines of conversation open during an upswing can help you gain better visibility to potential opportunities or alert you to potential storm clouds on the horizon.
Finally, make a decision to invest in your mental health. It’s easy to get really high in the good times and really low during the bad times. Recharge your batteries for the times ahead, whether that means taking a vacation or continuing to build your peer group and support systems.
While it’s currently a good time to make hay, be sure to pay attention to the rain clouds ahead. Sound decision-making now will lay the foundation for how your operation will fare in the next downturn.
Note: This article is provided for information purposes only. Readers should consult their own professional advisers for specific advice tailored to their needs. Information contained in this article may be subject to change without notice.
