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0207 PD: Managing your dairy: Are you making the high-impact decisions?

Timothy F. McNamara Published on 06 February 2007

There are a finite number of hours in a day – 24 to be exact. Most humans require or desire to spend 25 percent or more of those hours sleeping. That leaves up to 18 hours of alert consciousness to make the necessary decisions that impact your business, family and yourself. The approach you take to organize and prioritize those decisions goes a long way toward determining the success (or lack thereof) of your dairy business.


Your definition of success
Success means different things to different people. Most people considering financial progress and profitability as one measure of success. Others may determine that providing a quality food product to feed others while maintaining a rewarding lifestyle may be their motivation. Regardless of your individual definition of success, you are faced with decisions each day that have an impact on the success of your business.

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Decisions, decisions, decisions
Decisions come in all shapes, sizes and frequencies. Some decisions are simple and require little time or thought (what clothes am I going to wear today, do I want cream in my coffee, will I check the markets before or after I go to the barn?). These are decisions you make every day and may not have much of an impact on your success.

Other decisions carry a little more weight (do we treat or breed this cow or not, which cows will be dried off today, do we cut hay or harvest corn today, do I need to discipline or terminate an employee?). These decisions do not occur daily and tend to have more of an impact on results.

Then there are some “big” decisions (should I expand my dairy, should I let someone else raise my calves or grow my feed, should I look to exit the business?). These are the major decisions dairy producers may face only once in a lifetime.

As the pattern shows, the less often a decision is required, the most impact that decision is likely to have. Conversely, the more often a decision is made, it is less likely to have a major impact. Another way to look at it is: The more frequently you make a decision, the easier it is to correct if you make a mistake. The less often you have to make a decision, the harder it is to correct if you make a mistake. So you want to be as right as you can on the “big impact” decisions that tend to occur less frequently.

What are your decisions?
Dairy operations come in all shapes and sizes, and there is not one model that is a guarantee for success. In that same fashion, decisions made on a dairy also come in all shapes and sizes. Following is a short exercise for you to make a quick list of some of your decisions and then analyze those decisions for their impact.

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•Exercise #1: List five decisions you make every day.
Now go back and review these decisions for their impact on your operation. Rate them on a scale of 5 (highest impact) to 1 (lowest impact).

•Exercise # 2: List five decisions that are the most difficult for you to make.
Now go back and review these decisions for their impact on your operation. Rate them on a scale of 5 (highest impact) to 1 (lowest impact).

•Exercise #3: What are the five activities that take up most of your day?
Now go back and review these decisions for their impact on your operation. Rate them on a scale of 5 (highest impact) to 1 (lowest impact).

•Exercise #4: What are the five activities that you least like to do?
After completing these four lists, are there any activities that appear on more than two lists? If there are activities appearing on more than one list, how did you rate them for impact to your operation? Are they “big” decisions or “small” ones? Do they have a major impact on your success or a minor impact?

Are these activities only you can do or can you delegate them to others who may have more time than you, who may be able to do the activity better than you or others who may have more interest in doing that work than you do (“love what you do and do what you love”)?

A tale of two dairy producers
This is a story about two dairy producers who had similar dreams and goals. Both wanted to expand the size of their dairy operation for similar reasons. Both wanted to make more money. Both wanted more quality time with their family. Both wanted to create a business that could be passed on to the next generation of their family. Finally, both wanted to be recognized as “successful.”

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Producer A spent a lot of time on a comprehensive business plan. This owner began with the end in mind – he knew what he wanted and had a good idea of what it would take to achieve his dream. He had a good herdsman, which allowed the producer the opportunity to get away from the day-to-day activities of his existing dairy and visit other dairies all around the country. Early on in the process, he engaged the services of an experienced, qualified dairy consultant who had the ability to run financial projections, assisted in the creation of the business plan and helped locate additional specialized resources (builder, equipment dealer, nutritionist, veterinarian, lender, accountant and even a lawyer) to help put all the pieces together.

The dairy built by Producer A was designed for expansion. The location allowed for additional freestall barns and the parlor building was also expandable. Rather than continuing growing their own crops and raising their own replacements, he sourced strategic partners who were willing and able to perform these tasks and allow the producer to focus on making quality milk.

Producer B was actually two producers – brothers who had taken over the family farm and had expanded gradually over several years but had reached a point where new facilities were a real need (or at least a want). The brothers were known as hard workers who seldom took time off from their dairy – too busy to go anywhere. They grew their own crops and raised their own heifers because “nobody else could do it as well as they could.” Their goal was to build a new dairy as cheaply as they could. They took a “canned” design and an “off-the-shelf” business plan developed for someone else and just changed the names and a few numbers. With their focus on “cheap-cheap-cheap,” price was more important than quality when it came to the facility and the expansion cattle.

As their new dairy was being built, they tried to keep the cost down by doing some of the work themselves. At the same time, they still had 200 cows in older facilities gradually being neglected as the shiny, new dairy took more and more of their focus and time.

Before Producer A started his dairy, he sold his existing herd and bought open heifers. This freed up his time from milking and allowed him to devote more time to preparing for his new dairy. He spent some time working in a nearby larger dairy similar in size and design to what he was building. He was able to sell his herd and buy two open heifers for every cow he sold. He controlled the feeding and breeding of these heifers and hoped his timing was good so the facility would be finished just before the heifers would start calving. Luck was on his side, and he started with new animals that had been under his management and his start-up went pretty well.

The B brothers, on the other hand, kept doing all the things they used to do on their existing dairy: milking, feeding, growing crops and raising heifers. When the new facility was completed, it was a big day for them when they moved their existing herd into their new home. Unfortunately, many of the cows did not take well to their new home and ended up being culled.

The brothers continued to work harder – that’s what their father had taught them to do when things got tough. They did the feeding, the breeding, the calves, the crops and were so tired at the end of the day that doing the books was the last thing on their weary minds.

I think you can guess how these stories end. Producer A was able to expand his dairy after only three years (a good start-up and very good milk prices coupled with excellent management and focus on the major decisions) and continues to prosper today. Someone else still grows the crops and raises the heifers, which allows the producer to maintain his focus on producing a large quantity of high-quality milk from healthy, pregnant cows cared for by a well-trained and motivated workforce.

The B brothers continued to struggle with poor milk quality, low production, poor reproduction and inferior feed and heifer quality. It wasn’t through lack of effort, but their focus was doing the $10-per-hour jobs while the $200-per-hour decisions went unmade.

Five focused financial benchmarks
Being in the lending business, I can’t end without spending a little time talking about numbers. The amount of production and financial information available and required for a successfully managed dairy can be staggering. Many consultants have programs that will combine key production and financial data into meaningful information you can use to better manage your operation. From a lender’s perspective, here are five financial ratios you should calculate for your operation:

1. Working capital per cow less than $200
Working capital is current assets minus current liabilities. This is a measure of the liquidity of your dairy. More simply put, it measures your ability to pay your bills on time, to withstand some financial or production adversity and to be in a position to take advantage of opportunities when they present themselves.

Two hundred dollars per cow may seem like a lot of money to have in the current section of your balance sheet, especially if you are paying interest on noncurrent liabilities. However, in the business world, “cash is king” – ask any Fortune 500 company or look at their balance sheet. Having good liquidity helps you maintain a healthy independence from your lender.

2. Debt per cwt less than $20
Total liabilities divided by the hundredweights of milk sold per year; this is a measure of your leverage. An old measure was “debt per cow” and the measure used was less than $3,500 per cow. However, not all cows are created equal, and cows are not what you produce and sell – it’s hundredweights of milk. A cow that gives 24,000 pounds of milk has the ability to service more debt that one that gives 18,000 pounds of milk, assuming cost of production is similar.

3. Debt service per cwt less than $2.50
Debt service (principal and interest payments for a year divided by the hundredweights sold per year); this ratio gives you an indication if your debt is structured properly or if you have room to take on additional debt. If your debt service is over $2.50 and your milk price plus other income is $14.00, that leaves only $11.50 per cwt for feed, replacements, labor and other expenses. If your debt per cwt is less than $20 but your debt service per cwt is over $2.50, talk to your lender about restructuring your loans.

4. Owner equity greater than 40 percent
Dairies thinking about expanding need to calculate what their owner equity after expansion will be. Owner equity percent is your net worth divided by total assets. Another way of looking at this ratio is what percentage of your assets are paid for.

Yet another way to look at this number is what is the ratio of your equity to the lender’s equity. At 40 percent equity, the lender has 60 cents of loans for every 40 cents of your equity. In other words, the lender has 50 percent more at risk than you do. As owner equity drops below 40 percent, the lender has an increasing share of equity in the operation and will likely require more loan covenants (and a higher interest rate) to mitigate the increased risk.

5. Net profit per cwt greater than $2.00
This may seem like a high number and with the prices of last year, it’s a challenging goal. However, if your herd is producing 24,000 pounds per cow, that’s $480 profit per cow, which should be achievable with normal milk and feed prices.

Conclusion
There is no “silver bullet” answer to achieving success in the dairy business. Success comes in many sizes and styles. A common denominator of successful dairies is an understanding of the decisions and activities that have the greatest impact on profitability and the ability and willingness to focus on those decisions and activities. PD

—From 2006 Vita Plus Dairy Summit Proceedings

Timothy F. McNamara
Vice President of AgriBusiness Capital

To contact Tim,
e-mail him at

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