checkbox facebook google-plus hamburger help linkedIn search twitter YouTube

Your Ag Loan, Your Way.

Learn More
Email Newsletter Signup
  • I want notifications on ...
Newsletter Signup

Creating Efficiencies and Identifying Opportunities Through Benchmarking

Date: 
Author: 
Compeer Financial
Educational Opportunities: 
Articles
Interests: 
Dairy
Home > Education & Events > May 2017 > Creating Efficiencies and Identifying Opportunities Through Benchmarking
Share:

Depressed milk prices made 2016 a challenging year with slim margins for dairy producers around the world. When faced with tighter margins, benchmarking can help you find ways to create efficiencies and increase profitability. Benchmarking aids in seeing the big picture while also providing the opportunity for in-depth analysis.

Benchmarking compares your operation against the performance of your peers, and yourself, over time. Compeer Financial’s Dairy Consulting Team recently compiled our 2016 Annual Benchmark. Our experienced dairy consultants use the Dairy Profit Manager (DPM) financial model and industry knowledge to accurately analyze the performance of dairy businesses. For 2016, the Annual Benchmark Report includes 58 farms utilizing the DPM with more than 81,000 cows primarily from Wisconsin, Minnesota, Michigan, and Ohio. The average number of cows on each farm was 1,399 in 2016, ranging from about 300 to 5,800 cows.

Milk Production
Many of the clients in Wisconsin and Minnesota discontinued the use of BST in 2016, resulting in decreased milk production. When corrected to 3.5% butterfat and 3.2% protein content, milk production decreased by 0.5% to an average of 87.7 #/cow/day. The top 25% of dairy operations showed production of 89.1 #/cow/d, which was essentially the same as in 2013 (89.0 #/cow/d). The top 25% was comprised of 15 operations encompassing almost 20,000 cows, as ranked by net income/cow (pre-tax).

Earnings in a Low Price Environment
In 2016, the average class III price decreased for the second year in a row. At 14.86/cwt., it was down $0.91 from 2015 and down almost $7.50 from the highs of 2014. Clients also saw a decrease of $0.18 in their 2016 basis, down from $1.99/cwt. in 2015. Contributing to their higher net income, the top 25% of clients earned an additional $0.48/cwt. over the average, or $2.29/cwt. for their basis. Overall, clients received gross milk revenue for 2016 of $16.87/cwt., which includes the average class III price of $14.86/cwt., a basis of $1.81/cwt., and milk marketing gains of $0.19/cwt. (includes forward contracts, futures, options, and LGM premiums and payments).
In addition to lower milk prices, 2016 earnings were also hindered by decreased cull cow income and livestock sales (calves, steers, and hogs). Fortunately, gross expenses also decreased in 2016, stemming the decline in overall net profits to some extent. Client average net earnings were in the red again for 2016, down to $-211/cow versus $-33/cow in 2015, marking the lowest net income in the last five years. The top 25% were able to make money, with earnings at $290/cow, although this was still only about half of the earnings from 2015. Looking at net income on a per cwt. basis, this equates to $-0.74 for the average and $1.01/cwt. for the top 25% of farms.

Understanding Cost of Production Drivers
Overall, 2016 Cost of Production (COP) decreased for the second straight year $0.53 to $17.06/cwt., although it was not as substantial as the $1.77 decrease from 2014 to 2015. Cost of production can be broken into seven main categories – feed cost, labor cost, net herd replacement cost, capital cost, other production costs, overhead costs and other income. As opposed to the increased net herd replacement cost and increased capital cost, all other costs were down, contributing to the decreased COP. The top 25% of clients in the database had a 2016 energy corrected COP of $15.75/cwt., accomplished by lower costs across the board.  Let’s look at some of the drivers to cost of production.

Feed costs decreased $1.23 to $9.10/cwt. on average, marking the 3rd straight year of declining feed costs. The top 25% of clients were in the same range with energy corrected feed costs of $9.07 per cwt. for 2016. Feed expense in the benchmark is representative of all feed costs, including purchased and home raised feeds. Lower feed costs were driven by two factors: 1. Decreased grain and commodity prices throughout 2016 2. Clients continuing to harvest high quality, home raised forages. This allows them to utilize a higher percentage of forages in the diet and decrease purchased commodity usage. Simultaneously, the dollar value of the forages have decreased translating to substitution of purchased commodities with high quality, low cost forages.

A subset of clients are also benchmarked specifically on their feed costs and income over feed cost (IOFC). Income over feed cost is milk income per cow per day less feed cost per cow per day. IOFC is used to evaluate feed costs relative to milk income — if you’re paying more for a high end ration, it’s important to ensure you’re seeing returns on the milk income side. Milk income has decreased faster than feed costs over the last three years and IOFC, subsequently, dropped $0.35/cow/day from 2015 to 2016. 

Labor is typically the second highest expense on a dairy operation. Labor costs in the benchmark include wages, payroll taxes and benefits paid to employees.  Salaries and benefits paid to owners (including wages shown as draws) are also included.  Surprisingly, there was actually a decrease in labor expense for 2016. While hired labor has held mostly steady over the last three years ($2.87, $2.87, and $2.84 from 2014-2016 respectively), 2016 saw a decrease of $0.08 in owner draws. While this seems like an unsubstantial amount, it represents a decrease of over $30,000 in owner pay and benefits when projected on the 394,000 average cwts. produced for the year. Top 25% producers had a labor expense $0.35 below the average at $2.87/cwt. The Top 25% had essentially the same family labor costs as the average, with the variance being driven almost entirely by differences in hired labor costs.

When benchmarking your labor values, take into consideration the full scope of your operation and how that may be different from the dairies included in this year’s benchmark.  Operations that raise all of their young stock as well as produce all of their forage and grain needs may have labor values above $3.50/cwt., whereas operations that only harvest milk should be looking at costs less than $2.00/cwt. It is also important to understand if the owner draws taken out of the business are actually payroll (and should be included in labor expense), or if they are truly draws for personal or succession and transition purposes.

Cull cow prices decreased substantially from 2015 to 2016 (down $350 to $889/cow on average), curtailing what had been a pleasant income support in the face of declining milk prices. This, in turn, resulted in a jump of $0.33/cwt. in net herd replacement costs for the year. This is the highest net herd replacement cost has been in the last five years. Net herd replacement cost is calculated by the value of animals leaving your herd (cull, dairy sale or death) less any revenue received for those animals removed. The Top 25% of clients had cull cow income of $928 per cow and Net Herd Replacement expense of $1.20/cwt. Operations should target a value of a $1.50/cwt. or less. However, a common thread among elite producers is net herd replacement costs closer to $1.00/cwt.

Choices made by dairymen can have a real impact on their net herd replacement cost.  Choosing when animals are culled can substantially alter revenue received.  Managing heifer inventories to adequately supply replacement needs of the dairy, without artificially inflating the number of cows removed from the herd is another opportunity to improve net herd replacement cost.  Genetic testing, now available as a management tool, has shown that not every heifer is genetically superior to the cow she may be replacing. If a producer does have an abundance of high quality heifers and cows, dairy sales provide one more alternative to increase cash sales and decrease net herd replacement cost.

Capital costs were also up for 2016, with the benchmark average increasing $0.21 to $2.53/cwt. Capital costs increased in 2014 as producers caught up on deferred maintenance with their additional revenue, but then held steady in 2015. Capital costs include depreciation, interest expense and any lease payments.  The depreciation value used in our benchmark report is management level depreciation and not tax level.  How an operation is balancing the depreciation cost versus interest costs, labor efficiencies and repair costs can have a significant impact on how their operation compares to the averages.

Overhead costs (admin, fuel, utilities, custom, etc.) decreased for the third straight year to its lowest point since 2012. Crop expenses (crop chemicals, custom hire, fertilizer, seed, land rent) were down by $0.16/cwt combined, with other expenses holding steady or having minor changes. The decrease in crop input expenses was not enough to offset the lower value of the crops harvested, with many clients showing a loss for their agronomy enterprises.

Evaluating your Balance Sheet
Losses of more than $200/cow also had a detrimental effect on the balance sheet. Owner equity decreased 4% and has receded to pre-2014 levels, while working capital per cow dropped more than $400, the lowest it’s been in the last five years. These two measures give a straightforward overview of how your business is set up for the long term and for the immediate future. A standard target for owner equity (net worth/assets) would be 55-60% for a steady-state operation, but can dip to 45-50% in growth stages. Ideally, you don’t want your lender to own more of your business than you do!

Working capital is current assets (cash, feed inventory, accounts receivable) less current liabilities (accounts payable, current portion, operating loans). To evaluate how well your business is structured for the near future, target a working capital per cow level of at least $600. This helps ensure you have the cash available to maintain cash flow, and also take advantage of prepayments, cash discounts, or unexpected capital purchases that can improve your operation’s efficiencies. These two items can also offset each other — if your operation is in a comfortable owner equity position, it can withstand erosion in working capital and earnings. Conversely, a strong working capital position can insulate owner equity against deterioration in down markets.
Despite the detrimental effects of the sagging milk prices on the dairy industry, a few bright spots can be found in review of the 2016 benchmark. There are several key items many of the top producers achieved in 2016 which allowed them to be successful.
  1. Develop and stick to a milk marketing plan that will allow you to protect yourself from the lows but still take advantage when the market rallies whenever possible.
  2. Maintain a strong working capital position so you can take advantage of any opportunities that arise. However, excess feed inventories can inflate working capital and can actually be a detriment to your operation. If you are maintaining a year’s worth of feed carryover, consider selling some feed inventory, planting more acres into cash crops, or sub renting land to increase cash inflow and decrease outflow for crop inputs.
  3. Feed prices continue to decline in 2017. Take advantage of improved IOFC potential by maximizing milk production to achieve 6.25 pounds of butterfat and protein combined per cow per day.
  4. Lastly, evaluate your culling program and target less than $1.50 net herd replacement cost.
Minor adjustments can have substantial effects. Scrutinize your financials to determine key areas where you can create efficiencies and maximize opportunities for profitability on your operation. Through diligence and high quality management, the Top 25% of clients in our study averaged earnings of $290/cow, proving money can be made in a challenging milk market.

For more industry insights from Steve and others from our dairy team, go to Compeer.com.
Comments
There are no comments.
 Security code