It’s no surprise the infusion of direct government payments to farmers helped many dairy operators weather the storm that was 2020. Those payments were necessary to help operators struggling with the many effects of the COVID-19 pandemic, but it’s not something you can build a plan around.
According to the USDA Economic Research Service (ERS), government payments in 2020 were five times their normal levels. The latest ERS outlook report also predicts net farm income will fall nearly 10% in 2021, the first year-to-year decline since 2016. Direct government payments are expected to drop $21.8 billion, or 46.3%, after rising $24 billion, or 104%, in 2020.
This raises a couple of important questions: What’s the best way to put unexpected income to work? Also, how do you position yourself for both current and future success when the government money stops?
Putting extra funds to good use
Whether it’s in response to a global pandemic or global trade issues, government payments are designed to fill a revenue gap. The operators who took the long view did just that. We found that dairy farmers, in general, used the government payments to build working capital, shore up their balance sheets and improve their resiliency. How?
- They built cash reserves.
- They managed their taxes.
- Rather than using excess cash to accelerate machinery purchases, they purchased feedstuffs they would use in 2021, building resiliency by maintaining their working capital and liquidity.
- They reduced open account balances and lines of credit so they could take advantage of cash discounts.
- They prepaid expenses.
- They used surplus cash to pay down term debt and/or contribute to non-investment retirement accounts.
The operators who didn’t do these things may have used the direct payments to get into deeper water. That is, they were using government payments to cover losses from previous years, masking long-term viability issues. While that may address some trouble spots, it doesn’t address your underlying business fundamentals. Bottom line: If it takes government payments year in and year out for you to break even, you’re probably in trouble.
The new breakeven
In the first quarter, milk prices came off their 2020 highs, and that means operators can expect margin compression. The combination of lower commodity prices, higher expenses and reduced government payments reduces your margin for error. That’s where a solid risk management plan comes into play. We’ve discussed the fundamentals before but, in short, a risk management plan should include:
- Scenario planning
- Dairy Margin Coverage
- Dairy Revenue Protection
- Controlling expenses
- Keeping current with your suppliers
- Taking advantage of discounts
This is especially important now because the current situation means it’s time to lower your breakeven cost of production. While milk prices are lower, feed prices are higher. Meanwhile, a tight farm labor market is increasing labor costs. All told, the cost to produce 100 pounds of milk has changed from what it was 12 months ago. Ideally, you should be recalculating your breakeven cost of production quarterly – annually at a minimum.
New administration, new opportunities
Direct government payments will likely be much lower this year. But with the new administration, there are likely to be government programs that will impact the dairy business, including efforts involving sustainability and climate change. That means farmers are going to have a seat at the table to determine whether there are other opportunities for additional revenue sources.
Navigating a year with lower direct payments requires a combination of looking through both the rearview mirror and the windshield. That is, taking an honest look back at your 2020 performance while determining how to navigate the road that’s ahead of you. In other words, did the government payments help build your resiliency or simply delay the inevitable?
The game changed drastically in 2020, and it’s going to keep changing as we move forward. Knowing where you are can help determine where you need to be.
For more agriculture industry insights, visit online (BMO Harris Bank).
Note: The opinions, estimates and projections, if any, contained in this article are those of the author. BMO Harris Bank endeavors to ensure that the contents have been compiled or derived from sources that it believes to be reliable and which it believes contain information and opinions which are accurate and complete. However, the author and BMO Harris Bank take no responsibility for any errors or omissions and accept no liability whatsoever for any loss (whether direct or consequential) arising from any use of or reliance on this article or its contents. This article is for informational purposes only.
