February 1, 2021 at 3:08 p.m.
Dairies need to operate as businesses
“There are things we can do as dairy producers to prevent (volatility), and working with your lender is one of them,” Sipiorski said. … “Let’s face it; dairy producers have a great deal of assets invested, and they need to be able to work with a lender to make good use of those and yet have some boundaries of what makes sense to make sure everyone is successful.”
Sipiorski, an agricultural business and financial consultant, presented “Financial knowledge your banker wants you to know” Jan. 15 during a Minnesota Milk Minne-Series webinar.
“We do need to plan,” he said about dairy farmers. “I know with cows, you get up in the morning, there are chores to do, cows to milk and other things. ... I’m going to encourage you to take a look at a longer-term plan then just what the day to day is.”
Planning is needed because of the volatility seen in 2020. The novel coronavirus pandemic caused major disruption in the food service industry, which is only back to $54 billion in sales compared to $68 billion before the start of the pandemic, Sipiorski said.
Large swings in the milk price also meant more government aid, which accounted for 42% of net farm income in 2020.
“We’re not talking gross income, we’re talking net income,” Sipiorski said. “That has been huge. Don’t expect that in the coming year.”
Sipiorski said a plan can help a farm manage potential inflation, which could happen as the country’s debt to revenue ratio increases.
“What happens with inflation is we have too many dollars chasing too few assets,” Sipiorski said.
On a dairy, Sipiorski suggests the debt to revenue ratio should be 1-to-1.
“I encourage you to look at your balance sheet,” he said. “Look at the amount of debt and divide it by the amount of revenue, the amount of gross income you’re generating on your farm. How close are you to 1-to-1?”
On a per-cow level, Sipiorski said debt should not exceed $10,000 per cow, and from a production standpoint, Sipiorski said not to exceed $20 of debt per hundredweight of milk.
“We see some farms exceed up to 2-to-1 (debt to revenue ratio),” he said. “The concern is paying things back. I know interest rates are low right now. We have to be careful not to get too far out.”
In the last 20 years, Sipiorski said the country’s private debt by individuals and debt from businesses has increased severely, with each category around the $14 trillion mark.
“Is debt wrong?” Sipiorski said. “It is not. It’s OK to borrow money as long as you do it for the right purposes.”
To stay ahead of inflation and debt, Sipiorski said a dairy must have productive assets. Every dollar used to buy an asset should generate at least $1 in return.
“Be careful when you buy assets that don’t generate you enough income,” Sipiorski said. “A good example is a dairy cow. We can buy a good dairy cow for $1,500 and that cow will generate between $4,500 and $5,000 in income. That’s a good investment.”
Sipiorski cautioned about high-priced tractor and land purchases.
“Think about the return you’re going to get on them,” he said.
According to Sipiorski, the top 30% of dairy producers in the United States earn $1.25 more per hundredweight of milk compared to the average producer.
“I’m going to encourage you to get your financials together,” he said. “This is a good time to do it. You can’t plant corn tomorrow so you need to get all your numbers in line, not only for your accountant for your taxes, but for your knowledge and your plan and to know what your profitability is.”
That $1.25 can add up to a significant amount of money over time.
“This is real money, and we need to figure out how to capture those kinds of dollars,” Sipiorski said.
Capturing as much profit as possible is important as production in the country continues to climb, the number of cull cows going to slaughter does not add up to where it should be to keep production down and grain prices increasing.
“Work closely with who does your nutrition work,” Sipiorski said. “It’s possible we might be short with energy on corn and soybeans (because of the increased price).”
Going into 2021, producers will be working on taxes.
“Please do not run your farm based on your 2020 income tax return,” Sipiorski said. “That’s a terrible way to look at it.”
Sipiorski said he thinks many producers manipulated the amount of taxes they paid by prepaying before the close of 2020.
“We can really distort the income on a farm by the amount of depreciation taken by doing prepayments,” he said. “Be careful of that.”
Other paperwork to take care of is an accurate year-end balance sheet.
“At the 31st of December, you need to spend a few days before taking inventories of feed and cattle,” Sipiorski said. “If you haven’t done your balance sheet, do it. Get the numbers as accurate as you can – the assets and liabilities. Compare last year’s net worth to this year’s net worth.”
Follow that by doing an accurate accrual income statement.
“This is different than your taxes, but you’re still going to use income and expense,” Sipiorski said. “For example, if you paid an extra $50,000 fee in 2020 and will use it in 2021, you have to back that out. If you do your income statement, it’s going to show you had a lot more expenses than really what you did have. You need to do the same with cattle and feed inventories.”
Talking to a lender about current low interest rates and restructuring loans is also something many farmers should be doing, Sipiorski said.
“We are in a different year of dairy farming,” he said. “It used to be if you took care of your cattle and your crops, you made money. And I can’t think of a better place to raise a family than on a farm. Today, we have to run the farm first with the numbers, take a look at those and then we can make decisions on how to make our farm better.”
Other benchmarks to pay attention to include net worth, working capital, return on assets, return on equity, operating expense and cost of production and asset turnover.
“Can you turn (a profit from) it in three years?” Sipiorski said. “If not, you have too many assets that are not productive and generating enough income.”
Having a cash income project is also important.
Knowing this information is important to running a successful business; however, Sipiorski said 20% of producers have a written business plan based on true cash income statement.
“Only 20% of dairy farmers do this and it ought to be much higher than that,” he said.
Milk marketing might be a part of this plan.
“If you’re going to do marketing, you have to educate yourself,” Sipiorski said. “Don’t just go out and start pulling triggers on marketing milk if you don’t understand what you’re getting into.”
Sipiorski suggested farmers work with cooperatives, brokers or extension agents to find more information.
Overall, Sipiorski said it is important for dairy farmers to write down business, marketing and transition plans, and communicate often with their lender.
“Want to get a lender’s attention? Show them you’ve done a cash projection. Lenders appreciate when you sit down with them early and you bring information to them,” Sipiorski said. “Less than 10% of producers will come in with the type of business plan I’m talking about. But we’ve got to do it today based on what we’re facing in agriculture.”
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