After the farm crisis in the 1980s, the Wisconsin Banker’s Association started to analyze a dairy farm’s financial situation,” said Kevin Bernhardt, agribusiness professor at University of Wisconsin-Platteville. This group evolved into the Farm Financial Standards Council. The group still meets once a month.
“The Farm Financial Standards Council looks at 12 factors to determine if a dairy farm is profitable,” Bernhardt explains.
“I consistently look at these 12 financial benchmarks when I analyze a dairy operation for a potential loan or loan review,” said Gary Sipiorski, ag business and financial consultant and a retired banker.
Sipiorski and Bernhardt spoke to dairy farmers about “Dairy’s Dozen,” during a recent Dairy Signal webinar sponsored by Professional Dairy Producers.
Sipiorski said the top 30% of dairy producers know how to care for cows and young stock. They grow and buy high-quality feed, create a positive working environment for family and employees, and know their numbers. Here are his 12 simple ways to look at the profitability of a dairy farm:
1. Ownership equity. For a minimum ownership percentage, “30% is a must, 50% is better,” Sipiorski said. There are three ways to calculate ownership equity:
- equity to assets (at least 30% to 70%)
- debt to assets (at least 30% to 70%)
- debt to equity
“If you have $600,000 equity in a $1 million farm, that translates to a 60% equity position,” Sipiorski said.
“If you pick one, you get the same information from the other two,” Bernhardt explains. “They’re all there because everyone likes something different. Just identify which one you are using.”
2. Current equity. “This is probably the second factor I look at when I am evaluating a loan,” Sipiorski said. Ratios should be between 1:1 and 1.5:1.
Current equity is figured by subtracting current liabilities from current assets. Current assets include cash, savings, receivables (what people owe you), feed, market steers and hogs. Current liabilities include payables over 30 days, past-due rents, past-due real estate taxes, principal due in next 12 months and leases due.
3. Asset turnover. Asset turnover is determined by dividing total assets by total revenue. Assets include the buildings, equipment, land and livestock.
“If you have a $1 million farm and you have $333,000 in revenue, that is 33% asset turnover,” Sipiorski explains. “If you had the same revenue for two more years, you would turn the revenue in three years on this farm which is pretty good.”
Sipiorski said the average dairy farm in the U.S. turns their assets on average in four years, or 25% per year.
“Two years, or 50% per year, would be better,” he said. “I see dairy farms who take five years to turn assets.”
4. Debt per cow. Debt per cow of “$3,000 to $5,000 is pretty comfortable,” Sipiorski said, adding “$10,000 debt per cow should be the maximum. Debt per cwt of milk should be about $20 per cwt. Less is better.
“You need to look at this when you buy something,” he said. “If you buy a cow, she will generate about $5,000 in income in a year. A good dairy cow will cost about $2,500. There’s a lot less return on investment for a tractor. These are benchmarks you can use to see how you are doing.”
5. $1.25 to $1. “After you figure all of your expenses including family living, if you have $1.25 to pay $1 worth of interest and principal, you are doing pretty well,” Sipiorski said. “If interest went up 2%, would you be able to still work within these recommendations?”
6. Income per cow. Sipiorski figures a cow will generate about $5,000 gross income per year including milk sales and sales of breeding stock, calves and cull cows. To figure income per cow, divide total gross income from dairy only by the number of cows in your herd.
“Do not count grain sales or other income,” he said. “If you are raising some corn or soybeans on your farm that you take out of there and sell, don’t include that. Subtract that off total expenses on the farm and just look at the dairy farm on its own.”
7. Operating cost as a percent of total income. “When you figure this, pull out interest and principal and don’t include depreciation,” he said. “Be careful if you have done prepay. Don’t include that. Divide operating cost by total revenue.”
According to Sipiorski, operating cost as a percent of total income should be no more than 70%. “You don’t want to push past 80%,” he cautions.
8. Feed cost. Feed cost is usually the No. 1 expense on a dairy farm, Sipiorski said. It usually costs 30% to 45% of the milk check.
“Are you raising all of your forages and grain or are you buying it all? If you are buying most or all your feed, it will cost you more,” he said.
Sipiorski said it takes about 1.5 acres to provide forages for a cow and an acre per cow for grazing. You will need about 0.75 acre per cow for forage for youngstock and about 0.75 acres per cow for grain for the milking herd. On a conventional farm, he usually figures each cow in the milking herd will need 3 to 4 acres total.
9. Cost of producing 100 pounds of milk. “Ninety percent of income comes from milk sold,” Sipiorski said. “This includes all expenses for producing milk, including interest, principal and family living expenses.”
For example: $450,000 of milk divided by 26,000 cwt is $17.30.
“It could be in the $16.50 to $21 range per cwt,” he said. “Some organic herds may be $25 to $28 per cwt.”
Bernhardt said dairy farmers need to know their cost of production. “If you look at your cost of production and it’s too high, you may want to lower it by lowering some of your input costs. Maybe you want to switch to robotic milkers or grazing. Every operation is unique.”
10. Return on assets. According to the Farm Financial Standards Council, a 1% to 5% ROA is a pretty good return. Sipiorski said he likes to see a 6% ROA. “We want to make sure we are setting up a dairy for success,” he said.
ROA is calculated by dividing total assets into net income (include depreciation but no interest).
11. Return on equity. Sipiorski said he likes to see an 8% return on equity. Return on equity is figured by dividing net income, including interest and depreciation, by owner equity.
12. Operating profit margin. Sipiorski likes to see a 20% profit margin. Operating profit margin is figured by calculating net income, including all expenses, depreciation and family living, and then subtracting 10% to 25%.