Editor’s Note: The following is the second article of a two-part series including excerpts from the bulletin “Dairy Excel’s 15 Measures of Dairy Farm Competitiveness” found at http://ohioline.osu.edu/b864/index.html
We are pleased to share our measures of dairy farm competitiveness. In our judgment, these measures represent key characteristics of the most competitive dairy producers in the Midwest. Some dairy producers already exceed some of the measures. Dairy producers who meet most of the measures are competitive with dairy producers anywhere in the world and enjoy a high standard of living.
Each of these 15 measures fall into 10 broad areas, which together provide a good view of the competitiveness of a dairy farm business. The 10 areas are:
1. Rate of production
2. Cost control
3. Capital efficiency
4. Profitability
5. Liquidity
6. Repayment schedule
7. Solvency
8. Mission
9. Ability to maintain family’s standard of living
10. Motivated labor force
Six of these categories will be discussed in this article.
Measure 9: Liquidity
•As measured by current ratio
•Calculation: Current assets ÷ current liabilities
Current assets normally are converted to cash during the year (e.g., cash, stocks, bonds, feeder livestock, accounts receivable and inventories, such as feed).
Current liabilities are financial responsibilities that will fall due within one year of the date of the balance sheet (e.g., accounts payable, operating loans, principal portion of scheduled loan payments and accrued expenses).
A business must be able to pay its current obligations and have a cushion for unexpected cash shortfalls. Cash shortfalls may occur because of disease outbreaks, lower than expected milk production, lower milk prices or higher input prices. A current ratio above 1.0 indicates a farm has more current assets than current liabilities. A competitive dairy farm must pay its bills and keep its bank obligations up to date.
•If current ratio is low:
–A persistently low current ratio indicates a major cash flow problem.
–Remedies for profitable businesses include:
1. Refinancing existing debt with longer repayment terms.
2. Selling nonessential intermediate or long-term assets (e.g., machinery and investments).
•If current ratio is high:
–High current ratios indicate surplus cash. Current assets usually generate lower returns than other assets. If your current ratio is high, consider investing in assets with higher returns.
Measure 10: Repayment schedule
•As measured by scheduled debt payment (principal, interest and capital lease)
•Calculation: (Total annual scheduled principal + total annual scheduled interest payments + total scheduled capital lease payments) ÷ gross farm receipts x 100
Almost all businesses manage debt. Scheduled annual debt payments as a percent of gross farm receipts is a good measure of competitiveness. Too much scheduled principal, interest and capital lease payments seriously affect the ability of a business to meet cash obligations and have enough left to provide desired operator income and to reinvest in the business.
•Factors affecting scheduled annual debt payment as a percent of gross farm receipts:
–total farm debt
–how debt is structured (short, intermediate or long-term)
–interest rates
–gross farm receipts
•If scheduled annual debt payment as a % of gross farm receipts is too high:
When scheduled debt payments are too high and cause difficulties in the farm business, a manager must explore options, then act. If the business has significant short-term debt, rescheduling some of that debt over a longer (but realistic) term will decrease annual payments. If currently available interest rates are lower than those you are paying, refinancing is an alternative worth investigating.
Reducing total debt through sale of unused assets or carefully planning, controlling and spreading debt over more cows are also options. However, any alternative will only be successful if the business is profitable.
Measure 11: Solvency
•As measured by debt-to-asset ratio
•Calculation: (Total farm debts ÷ total farm assets) x 100
Solvency is a measure of the ability of a business, at a point in time, to meet all debt obligations following sale of all assets. This is measured by the debt-to-asset ratio. The debt-to-asset ratio increases as the business incurs greater levels of debt, and it decreases as debt is paid off. A business with little debt has a debt-to-asset ratio close to zero.
Debt-to-asset ratios will normally vary. Higher ratios are common in new/expanding businesses and often approach financially stressful levels. High debt-to-asset ratios are acceptable for limited periods of time when plans and projections indicate the business will quickly generate funds to pay down debt and bring the ratio below the competitive level.
Measure 12: Solvency
•As measured by debt per cow
•Calculation: Total farm debt ÷ (lactating cows + dry cows)
Another way of looking at the ability of a dairy farm to meet its debt obligations is by looking at total debt per cow. While the debt-to-asset ratio measures the overall debt position of the business, the debt per cow indicates how a manager would repay the debt. As the profit center of a dairy operation, cows generate the money needed to make principal payments.
•If debt per cow is too high:
When a business has debt per cow levels significantly higher than $2,000, it may experience difficulty meeting all principal and interest payments.
Solutions to this problem could include:
–selling any unproductive assets and paying down debt
–increasing number of cows with little additional debt
–increasing net income per cow and paying down debt
–withdrawing less from the farm business for family living and paying down debt
•If debt per cow is too low:
If a business has a very low debt per cow and is not highly profitable, the management team should assess the operation to consider if moderate investments could increase efficiency and profitability.
Measure 13: Mission
•As measured by management team agreeing on why they are in business
•Rationale
The management team must agree about why they are in business. Each member of the team having a different “mission” will inevitably lead to one battle after another and many misunderstandings as each manager works toward his or her own personal mission.
For example, one manager may focus on making a lot of money, another may want time with a spouse and family, while others may strive to have the top herd in the county, district or state. Having different missions can stifle decision making on a broad range of issues. These problems often stifle business competitiveness and ultimately may lead to a breakup of the business.
Developing a written mission statement helps a management team focus on what is important and begin working together toward common goals. As a unifying statement, the mission informs everyone where the business is headed and what each person’s role should be. In times of tension and disagreement, a mission can help everyone focus and work together.
A management team should review the mission statement regularly, adjusting it as necessary to prevent staleness and complacency.
•Suggestions for developing a written mission statement:
1. The management team should commit to developing a written mission statement.
2. The team should decide who should participate in developing the mission statement. Most businesses include the whole management team. A few include everyone involved in the business.
3. This optional step breaks the process down into smaller, simpler steps. Those involved in developing the mission statement outline key elements prior to writing it.
Questions to answer include:
–Why are we in this business?
–What are we trying to achieve?
–What values are important to us?
–How do we want this business to impact our employees, families, customers, consumers and the dairy industry?
–How would we like this business to look in 7 to 10 years?
4. The final step is to work together to draft a mission statement based on the values of those in the business. This is not an easy process, and it usually does not happen in one meeting or in an hour or two.
Once developed, the mission statement is a powerful tool to direct the business and focus the management activities where they will have the most impact. However, because people and their environment influence businesses, the mission statement should be reviewed and revised every few years, if needed, to reflect the changing goals of the management team and the external and internal environment of the business.
Measure 14: Maintain family’s standard of living
•The operators maintain or increase their standard of living by continual change to adopt proven technology and capture economies of size so families supported by the business can maintain their standards of living.
Families usually wish to maintain or increase their standard of living over time. Because of inflation, farm income must increase or standard of living falls. Above-average dairy farmers who have improved management, adopted technology and increased production per cow have only maintained or slightly increased income per dairy cow over time. Thus, the primary way of increasing dairy farm income is to increase the number of cows on the farm.
Farm families who have neither the desire nor resources to expand their herds have several alternatives. The family may retire existing debt or invest in financial assets, such as stocks, bonds and mutual funds. Retiring debt will reduce the interest expenses of the farm in the future. Investments in financial assets will provide returns which can provide money for family living in future years.
Another alternative is to seek off-farm employment. Cash flow projections will indicate whether or not these options will provide enough funds for family living.
Measure 15: Motivated labor force
•Managers who use personnel management practices lead to well-trained, enthusiastic, empowered family members and employees who share a commitment to the mission and goals of the business.
•Sample personnel management methods:
–Assess personnel needs, supervisory skills and working conditions.
–Develop job descriptions.
–Match workers with job descriptions.
–Hire employees who fit job descriptions.
–Develop a thorough training program.
–Train and reward employees.
–Improve your communication skills.
–Schedule work effectively.
–Train and coach your employees.
–Evaluate employee performance and provide feedback.
The fork in the road for dairy farms
Dairy managers that want to stay in business have to be competitive. Competitive dairy producers should plan on exceeding most of the 15 measures in five years. Unprofitability, as a result of not meeting these measures, may force a dairy operation out of business. Of course, the strategies you use to increase your competitiveness will depend on your current situation.
•Managers who are already competitive
Managers of most dairy farms are already doing many things right. However, to remain competitive you will have to continue to improve your management skills, adopt new technology and grow.
As you decide the course of your business, you should carefully consider your alternatives. Becoming overly complacent or attempting to implement change too rapidly are two pitfalls to avoid as you make important business decisions.
If you become complacent, the industry will pass you by and you will lose your competitive advantage. If you are winding down the farm and planning to retire, however, this may be an acceptable course.
On the other hand, a taste of success may leave you hungering for more and more, and right away. You must be careful not to move too quickly, stretch yourself too thin or rashly adopt a new and unproven technology. Unexpected setbacks may cause you to lose everything.
Dairy farming is a dynamic business. If you want to stay competitive over the long haul, you will have to continue to change and grow as a manager. You will need to continue to learn about management and how to apply the five functions of management:
1. planning
2. organizing
3. staffing
4. directing
5. controlling
You also will need to become an expert at creative problem solving, which cuts across all five management functions.
•Managers who want to become competitive
If your dairy farm currently is not as competitive as you would like, we suggest following the six steps outlined in this section. You may be in a position where income is modest, resources are available, you have good management skills and a desire to improve and you want to continue operating a dairy farm long-term. If this is the case, it is time for you to make some changes.
–Step 1: Prepare a written mission statement
Before you do anything, you (and your management team) need to prepare a written mission statement for your farm. You must know why you are in business and what you want to accomplish to become competitive. Discuss your mission statement at length and revise it until it clearly states why you run a dairy farm.
–Step 2: Prepare a written list of long-term goals
Next, your management team should prepare a preliminary written list of goals you believe will make your operation more competitive. Include more long-term goals on your list than you can possibly accomplish. Make sure you write the goals down. Unwritten goals are like uncaught fish; they are just dreams.
If you are better at coming up with good ideas than writing them down, ask your spouse, key employee or member of the family to do the writing.
–Step 3: Share your goals and revise them
Share this preliminary list with members of your family and others involved in the management of the business. Involve everyone. This process will require all involved to listen to each other and compromise.
Others will likely suggest different goals. Be open to their suggestions, and expect them to expand and help improve your preliminary list. Encourage others to suggest additional goals or to modify those initially suggested.
Addressing the following questions may help you evaluate your list:
1. Does each goal fit with the reason you are in business?
2. Is the goal realistic?
3. Does the goal take advantage of your strengths and opportunities?
4. Does the goal address your weaknesses and any factors threatening your business?
–Step 4: Prioritize your goals
Select one or two goals from your final list as top priorities. Most small business managers cannot attack more than one or two goals at a time. Pick one most of the management team agrees to start working on. Consider delegating responsibility for some goals to others on the farm.
–Step 5: Identify short-term goals
Identify short-term goals to support the top-priority long-term goal you have chosen to work on. A series of short-term goals lays the foundation for long-term success.
–Step 6: Determine logistics of attaining goals
Decide who, what, when, where and how for each goal. This is where you may share responsibility with others. Many of us erroneously believe if we want things done right, we must do them ourselves. However, there is a limit to how much each of us can do. If we have involved our family and management team from the start in determining long-term and supporting short-term goals, they will be anxious to help achieve them.
•Managers who want to become competitive but cannot
Some farms cannot be competitive because managerial expertise is low, managers do not have the interest or ability to improve, the farm has few financial resources or the operation is labor-intensive. Producers in this situation should make plans to support the family from nondairy enterprises.
•Managers who do not want to become competitive
Some dairy managers have no plans for making the operation competitive and, in fact, can afford to be noncompetitive. Many of these managers are in their 50s and 60s and carry little debt. The dairy operation may provide livable wages given the circumstances. Moreover, the manager does not have children, other relatives or employees with a desire to take over the operation.
Costs of being noncompetitive may be low as long as the manager is satisfied with the income generated by the operation. Managers in this position should plan on setting funds aside for their retirement.
Most other managers cannot afford to remain noncompetitive when means exist for making the operation more competitive. Younger farmers and struggling farmers who do not become more competitive eventually will find themselves in the previous group as managers who want to become competitive but cannot. PD
References omitted but are available upon request by e-mailing editor@progressivedairy.com.
—From Ohio State University Extension website
