Tuesday, 10 July 2012

On a Dairyfarm...Milk Income Minus Costs = $Whatever...Is totally Unacceptable.

Too few dairy farmers budget and when the milk price is volatile (as it is now) it’s really important. If you don’t you might lose more than just your shirt. You can not & must not be financially dependent on the milk price. That to me suggests that you are operating on thin risky margins.
Farm Business resilience depends heavily on Financial Efficiency, Solvency & liquidity. Some Farm Businesses manage upside risk better than other businesses & these often are not the same businesses that cope well with downside risk

We need to focus on our ability to cope with the current decreases in milk price, the sharp increases in feed costs & the highly predictable continued volatility (currency, EU, USA, Oil prices, weather extremes & political instability). i.e. Downside Risk!
Too many simply accept Milk Income Minus Costs = $ Whatever.
 Why? Why would you accept $Whatever? What do I mean $Whatever? I mean simply accepting what ever is left over $$$ at the end of the year. This is totally unacceptable!
 Dairy farmers need to concentrate on those factors that you do have control over within your farm gate. I would hope that in control pasture based dairy farmers aren’t too concerned about the milk price. After all you as an individual have little or no influence or control over milk price. What you do control is on farm spending & the efficiency of resource management & decisions related to spending. 
What I’d like to focus on is that you can control the financial outcomes with control over costs & having clear business objectives & targets. Financial results are pretty much in your court & your business planning. If you don’t have real conviction that you can set a financial target & achieve it year in year out something needs sorting with your farm business management.
 What I do know is that there seems clear evidence (not only in NZ but other dairying nations too) of “systems creep” toward more purchased inputs & cereal based diets & an associated drop off in pasture management skills. 
 So when the milk price drops individual farmers find that they or their system is locked into a higher cost structure & it’s more difficult to adjust quickly to a lower milk price. Along with the extra grain comes extra machinery, feed pads, feed bins, feeding systems & increased borrowing & debt servicing. All this spending occurs during periods of higher milk prices/the good times but the repayments go on regardless of milk price fluctuations.
On many farms there also seems a division of financial responsibilities between partners (which normally would be admirable but not this time).
 One person does the budget (and the books) & the second person does the farm spending. Sadly the second person spends as if there was no budget. It’s purely coincidental ofcourse that on many farms the budgetter & book keeper happens to be female & the farm spender happens to be male…..Yeah Right! 
Both Farm Business partners need to build the budget & budget rules then both partners or team members need to implement the financial plan & make it happen.  
Why Not Budget……. by setting a target for “Free Cash”. Now ring fence that financial outcome as “Not Negotiable”. The Free Cash Target must happen regardless of milk price! Let’s make some assumptions to illustrate the point. Let’s assume that discussions with your business & life partner results in a “Free Cash Target” of $100, 000 being set & ring fenced as being “Not Negotiable”. Free Cash is the amount of cash available for “spending off farm” after all farm working expenses, all fixed costs, household drawings, debt servicing & farm related expenses have been paid. Free cash is not household drawings or school fees.
So start the budget on your spreadsheet by locking in $100k Free Cash outcome. Now work backwards starting with fixed costs then variable costs & lastly milk income to secure the $100k Free Cash outcome which has been ring fenced as not negotiable.
The Budget Process is very different from Milk Income Minus Costs = $Whatever which is completely unacceptable.

 Free Cash Target plus Fixed Costs plus Variable Costs = Farm Income.

This Free Cash Budgeting process should allow the Target Free Cash to be generated each year regardless of Milk Price.
Maybe you start by working out what the reduced milk price will cost your business.
Now reduce your costs by that same amount. This downturn in prices should not be a surprise to anyone....it's been highly predictable & the market signals have been clearly visible & accessible on the web.
Back in 14th October 2011 I wrote another blog on this same page "Dairy Farm Profitability.....All Fur Coats & No Knickers" If you haven't read it you should by scanning down through the pages.
If we are looking for the good news story it's that when grain prices sharply rise the dairy down turn is normally brief.
Free Cash Targets must be Not Negotiable.


  1. Excellent Tom and very timely, we have so much control of production cost and so little control of milk price. Pay a farmer a high milk price for long enough and he will find an expensive way of producing it.

  2. Great comment Robert. The systems drift or creep toward more expensive cost of production ofcourse occurs during periods of relatively high milk prices. If you can keep your system simple & low cost then you profit both in the good times & in periods of low milk prices.