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Thoughts on utilizing dairy financial statements effectively

Lance Fenton for Progressive Dairyman Published on 24 May 2016

As the most exciting part of running a dairy operation, I know you’re dying to hear about how to do more with your monthly and quarterly financial statements. Of course, this may be a small exaggeration.

(Though, as an accountant, we do admittedly get excited about the numbers.)

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A dairy operation usually gets financials done because they have to, not because they want to: The bank financing them requires monthly and quarterly financial statements to keep their financing in good order. And, as most “have to” items, we want to put it in a drawer somewhere and forget that it exists so we can go on to the “real work” of dairying.

But as long as you have to get them done anyway (and pay for them anyway), you may as well utilize your financials to maximize your productivity and profitability.

Let’s take a moment to pull it back a bit. Why does the bank require monthly and quarterly financial statements? They want to make sure you’re still financially viable and healthy. If your operation starts to show a troubling trend that indicates you might not be able to sustain payments, they want to know that sooner rather than later.

It also helps them sleep better at night (and banks need their sleep) when they are reassured your operation is running well and the money looks good.

Banks usually look at these key ratios. (Make sure to discuss these with your accountant and lender when you receive your financial statements.)

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  • Current ratio (including herd and herd debt)

  • This is a measure of a dairy’s ability to meet its obligations for the next year; what you can turn into cash over the next year compared to what you will have to pay in cash over the next year.

  • Debt-to-equity ratio

  • This gives a ratio of who has provided the capital: bank loans versus investment capital

  • Breakeven analysis

  • Calculation of the revenues required to cover your operational costs on a hundredweight (cwt) basis

  • Debt service coverage ratio

  • The debt service coverage ratio is a measure of the cash flow available to pay current debt obligations. It’s essentially net income divided by total debt service (interest plus principal payments on loans).

  • Loan-to-value ratio

  • The loans you have outstanding compared to the value of the assets you hold

  • Every bank calculates this ratio a little differently. Most banks want you to be within a maximum of 65 percent to 75 percent loan-to-value ratio.

  • More importantly, banks are looking at the value of feed inventory and animals in comparison to operating lines of credit.

As the owner of your operation, you will want your financial numbers to be as positive as possible for the bank. Experienced operators are able to achieve this by focusing on a few areas. First, more refined operators will have a good idea of where their breakeven costs are on a cwt basis.

Second, having standardized operating procedures that are applied on a consistent basis (i.e., feed inventory counts done monthly, cow inventory reconciliation, etc.) make a big difference in the comparability of your financials month-to-month and quarter-to-quarter.

Feed costs drive a large portion of the income statement. If your feed inventory counts are misstated or inconsistent, it will wreak havoc on your feed expenses. Large variability in your feed costs will make it difficult to project future breakeven costs. This will impair your ability to make management decisions based on your financials.

Third, utilizing advisers who understand the dairy industry will ensure your financial statements contain industry-specific elements, creating a more professional image and giving your operation credibility in the eyes of the bank.

From the dairy’s side, you’ll find important details in the analysis of costs on a cwt basis. These will help you see problem areas that need improvement or tell you where you’re doing well.

For example, you should regularly be analyzing your production numbers and your feed costs on a cwt basis with your nutritionist. This is the single largest input into your operation, and even small variations in production can influence your feed costs on a cwt basis.

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I would also recommend reviewing statistical information on a monthly and quarterly basis. Common statistical calculations that should be reviewed are:

  • Average pounds of milk per cow per day
  • Butterfat and protein percentages
  • Percent of cows lactating
  • Cull and death loss rates

To better evaluate these numbers in context, use benchmarking data, which gives you an idea of where your operation is sitting among your peers. Using this data, you can quickly see where you are in alignment or out of alignment with similar operations.

It gives a common baseline to make improvements or, at minimum, understand your operation in comparison to the industry.

It’s important to consider that the financial statement will only be as accurate as your record-keeping. Part of maintaining accurate record-keeping is doing regular feed and animal inventory counts.

For example, harvest time for dairies that also farm occurs during Q2 and Q3, and inventory counts can be in a state of flux. This can also happen when purchasing large amounts of supplies and feed. Keep this in mind when using financials in making decisions.

When all is said and done, one of the best things you can do in business is to squeeze the most out of the things you “have to” do anyway, and financial statements definitely fall into that box.

While they are primarily for bankers, financial statement are an invaluable tool to manage your operation because they track more than just cash in and out. They give you a snapshot of where your operation is standing, where the problem areas might be and where improvements will make the biggest impact.

The bottom line is: I would encourage you to work with professionals who know your industry, pay attention to the items that the banks are tracking and recognize where your business processes are making a difference in the reliability and consistency in your numbers.  PD

Lance Fenton
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