Cut costs or improve production?
By Dan Gingue
Farm Business Advisor
How much less can be spent before the farm is cutting corners rather than costs?
During periods of depressed milk price, dairy farmers focus on reducing costs to conserve cash. When there is not enough money to go around, fewer purchases are made and many purchases are second-guessed. Dairy farming through 2009, I fully understand the actions farmers are inclined to take today.
It is natural to cut spending. However, will doing so without thoroughly evaluating the full effect on earnings result in decisions that cost more than they save?
The following comparison reflects the impact of increasing milk production thru management on a typical farm. The example 1,200 cow example farm "Baseline" projection has average milk production (shipping 80 lbs/cow/day), and well-controlled expenses. The farm's operating expenses are in the top 25% of the benchmark at $17.26/cwt. The farm is moderately leveraged at $4,300 debt/cow.
In the baseline projection, 80 lbs of milk shipped per cow in milk generates a net income of $349/cow/year. When milk shipped/cow/day is increased to 85 lbs, net income/cow/yr increases by $269 to $618. Making management adjustments (i.e. forage quality, cow resting time, etc) to achieve the 5 lb. increase in milk production will drive earnings with minimal additional expenses. Operating expenses, diluted by the additional milk volume, decrease $0.97/cwt. Net income increases $323,000.
In debt analysis, more income improves debt repayment capacity. At 80 lbs of production, the farm commits 16% of milk sales to debt service. This is reduced to 15% at 85 lbs. Reducing expenses won't impact this debt service metric.
This farm has the cost of production under control. For this reason, it will be difficult to reduce expenses by the $1.04/cwt needed to achieve the same $323,000 increase in net income. How much less can be spent before the farm is cutting corners rather than costs?
Net earnings or net income is what is left of total income after paying operating expenses. Losing sight of the income side of this equation puts a farm at a disadvantage now and slows financial recovery when milk prices increase. Utilizing a timely financial analysis program like Dairy Dashboard will indicate the areas of opportunity. The information empowers owners and managers to identify where their efforts will generate the greatest and quickest returns. Where do the opportunities lie, on the income side, or on the expense side?