Think about your last check-up at the doctor’s office. What questions did your doctor ask you? How did he or she determine you’re healthy or uncover any potential risks or problems? Now it’s time for you to be the doctor for your farm’s finances. Pull out your balance sheet and cash-flow records. Take a look at the following 12 ratios to determine your financial health.

It’s not only important for you to know these numbers, but it also makes for good discussion with your lender, who uses many more ratios to assess your dairy’s financial performance. By reaching your goals for the following 12 ratios, the others generally fall into place.

1.Income per cow: $5,000

Gross income must be generated regardless of the number of cows on your dairy farm. Items affecting income per cow include milk sales, cull cows, calf sales, government programs related to milk and patronage refunds.

Divide this number by the total number of cows on the farm, including dry cows. Although they may generate income, do not include other enterprises unrelated to milk sales, such as grain sales, steer sales, etc.

2.Operating cost as a percentage of gross income: 80 percent

In 1980, a dairy farm’s operating expense rate was 50 percent. Today, due to inflation of expenses and the way milk is priced, the expense rate is generally 80 percent. A quick way to get this number is to use Schedule F on your tax return.

Take the Schedule F expenses and add in family living. Then divide this number by the gross farm income. Make sure any prepayments are taken out. If any expenses were carried over and not paid, such as payables, make sure they are added in.

It would be better to use the farm-generated records from the income and expense report. However, many farms may not have these systems, whereas the tax return is readily available.

If you want to find the “true cash cost of production,” add all of the cash expenses for the year, add principal and family living, and subtract the tax depreciation. Now you have the cost of production that comes out of the checkbook. You may want to add a “wear-and-tear number,” such as 10 percent of the machinery cost.

3.Milk sold per cow:24,000 pounds for Holsteins (adjust for other breeds)

In 1945, the average U.S. cow produced 5,000 pounds of milk. Better breeding, nutrition, cow comfort and management have raised the pounds of milk each year. Higher debt loads are better serviced with more hundredweights sold.

4.Ownership equity: 50 percent

Ownership equity represents the percent of the farm you own. This is found on the balance sheet. It is determined by subtracting the liabilities from assets. That number is divided by the total assets. It should be 30 percent at minimum; more is always better.

Borrowing money is not a bad thing in this business that requires a lot of capital. The cash flow must be able to repay the debt in a time period that matches the life of the asset. In a money-stressed year, it will be difficult to go to a lender to borrow additional money when equity is below 30 percent.

5.Current equity: $2for each $1 of current liabilities

This ratio shows the ability to pay yearly operating bills. It says: For each $1 needed, $2 is available to pay. Current assets are cash, feed, money owed to you, steer sales or items that will be turned into cash in the next 12 months. Current liabilities are bills over 30 days, past-due rents or taxes, lease payments and principal payments.

6.Cost of producing100 pounds of milk: $17.50

See the expenses used in item #2 and divide those expenses by 100 pounds of milk sold during the year. A good target is $17.50. Bottom line: You need to produce milk for less than you sell it. You need a margin.

7.Feed cost: 20 to 45 percentof the gross income

This seems like a wide range, but it depends on how much feed you produce on your own. In general, it takes 1.5 acres per cow to produce enough forage and 0.75 acres per cow to produce enough grain for the milking herd.

Additionally, you need 0.75 acres per cow to produce forage for the youngstock. If you have this land available, the purchased feed cost should be around 20 percent of gross income. If you buy all feed, the cost will be 45 percent of the milk check.

Any combination will run between these numbers. Exceeding 50 percent will put a strain on the checkbook. High-feed-cost years, like 2012, will hurt. Feed is the biggest cost to a dairy, and each farm needs to evaluate individually, depending on variables such as needs and forage quality.

8.Livestock expense: 4 percent

This is the “canary in the coal mine.” The expenses in this area are breeding and veterinarian costs only. (Items like rBST are supply expenses.) If this number is higher, your dairy may have metabolic or other health issues. Hopefully, you catch the problems before generating your year-end numbers.

9.Debt per cow: $5,000

Any herd can only service so much debt; $3,000 to $5,000 should be manageable, but $7,000 becomes difficult to service. The debt per cow will depend on the farm’s ability and terms of the amortizations. This is a lender/producer discussion and decision. Many lenders now calculate debt per 100 pounds of milk sold, which generally will be $20 per 100 pounds of milk sold per year.

10.Debt coverage: Less than 20 percent of the gross income

This represents the amount of interest, principal or lease payments to be paid divided by the farm’s gross income. A goal of 15 percent of the gross farm income should be manageable, with a maximum of 20 percent for years of lower milk prices. Exceeding 20 percent will make it hard to pay other bills.

11.Asset turnover: 2.5 times

This ratio measures how many years it takes to turn the total farm assets, calculated by how much gross income is generated compared to total assets on the balance sheet. For example: A farm has $1,000,000 in farm assets and generates $400,000 in gross income; $1,000,000 divided by $400,000 means it takes 2.5 years to turn the assets.

The average U.S. farm turns assets in 3.5 to four years. That is too long. The farm either has too many assets or it’s not generating enough income. Think about this the next time you buy something. How will it affect asset turnover?

12.Total investment per cow: $7,500 to $15,000

This number relates closely to asset turnover. Divide the total assets by the total number of cows. A dairy farm needs a lot of capital, but you should have limits to stay competitive with other milking herds around the country and world.

Make sure assets used in the calculation are dairy cow-related (cattle, buildings, land and machinery used for the milk cows). Grain and other enterprises do not put all the weight of the dairy cows. Keep those assets out of the calculation. PD

Gary Sipiorski
Dairy Development Manager
Vita Plus Corp.