Benchmarking – comparing your operation against the performance of your peers and yourself over time – can identify ways to create dairy farm business efficiencies and increase profitability.
Compeer Financial’s dairy consulting team recently compiled its 2016 Annual Benchmark report, using the Dairy Profit Manager (DPM) financial model to analyze dairy business performance. The 2016 report includes 58 farms with more than 81,000 cows primarily from Wisconsin, Minnesota, Michigan and Ohio.
Herd size averaged 1,399 cows in 2016, ranging from 300 to 5,800 cows.
Milk production
Many of our Minnesota and Wisconsin clients discontinued the use of recombinant bovine somatotropin (rbST) in 2016, resulting in decreased milk production. When corrected to 3.5 percent butterfat and 3.2 percent protein, milk production decreased by 0.5 percent, to an average of 87.7 pounds per cow per day.
Cows in the top 25 percent of dairy operations – ranked by pretax net income per cow – averaged 89.1 pounds per cow per day, essentially the same as in 2015.
Earnings in a low price environment
Depressed milk prices and tighter margins made 2016 a challenging year for dairy producers. At $14.86 per hundredweight (cwt), the average 2016 Class III price was down 91 cents from 2015 and down almost $7.50 from the highs of 2014. Clients also saw a decrease of 18 cents per cwt in their 2016 basis, down from $1.99 per cwt in 2015.
Overall, clients received 2016 gross milk revenue of $16.87 per cwt, which includes the average Class III price of $14.86 per cwt, a basis of $1.81 per cwt, and milk marketing gains of 19 cents per cwt (includes forward contracts, futures, options and Livestock Gross Margin for Dairy [LGM-Dairy] program premiums and payments).
Contributing to their higher net income, the top quartile earned an additional 48 cents per cwt over the average, or $2.29 per cwt for their basis.
The 2016 earnings were also hindered by decreased cull cow income and livestock sales. Fortunately, gross expenses also decreased in 2016.
Client average net earnings were in the red again and the lowest in five years, down to $-211 per cow, versus $-33 per cow in 2015. The top 25 percent of clients were able to make money, with earnings at $290 per cow, but only about half of the earnings from 2015. On a per-cwt basis, net income was -74 cents per cwt for the average and $1.01 per cwt for the top quartile.
Understanding COP drivers
Overall, 2016 cost of production (COP) decreased for the second straight year, down 53 cents per cwt, to $17.06 per cwt. COP had decreased $1.77 per cwt from 2014 to 2015.
COP can be broken into seven main categories: feed cost, labor cost, net herd replacement cost, capital cost, other production costs, overhead costs and other income. In 2016, net herd replacement cost and capital cost increased, but all other costs were down.
The top 25 percent of clients in the database had a 2016 energy-corrected COP of $15.75 per cwt, with lower costs across the board.
Let’s look at some of the COP drivers:
- Feed costs (including purchased and home-raised feeds) decreased for a third straight year, down $1.23, to average $9.10 per cwt in 2016. The top 25 percent of clients had energy-corrected feed costs of $9.07 per cwt.
Lower feed costs were driven by two factors: 1) decreased grain and commodity prices throughout 2016; and 2) clients utilized high quality, home raised forages as a lower-cost substitute for purchased commodities.
A subset of 2016 clients are also benchmarked on feed costs and income over feed cost (IOFC). Milk income has decreased faster than feed costs over the last three years. Subsequently, IOFC dropped 35 cents per cow per day from 2015 to 2016.
- Labor costs, typically the second- highest expense on a dairy operation, include wages, payroll taxes and benefits paid to employees. Salaries and benefits paid to owners (including wages shown as draws) are also included.
Surprisingly, labor expenses decreased in 2016. While hired labor has held mostly steady over the last three years ($2.87, $2.87 and $2.84 per cwt from 2014-2016, respectively), 2016 saw a decrease of 8 cents per cwt in owner draws. While this decline seems small, it represents a decrease of over $30,000 in owner pay and benefits when projected on the 394,000 average hundredweights produced for the year.
Producers in the top 25 percent had a labor expense 35 cents below the average, at $2.87 per cwt. Among that group, family labor costs were essentially the same as the average, with the variance driven almost entirely by lower hired-labor costs.
When benchmarking your labor values, take into consideration the full scope of your operation and how that may differ from the dairies included in this year’s analysis.
Operations that raise all of their youngstock and produce all of their forage and grain needs may have labor values above $3.50 per cwt, whereas operations that only harvest milk should be looking at costs less than $2 per cwt.
It is also important to understand if the owner draws taken out of the business are actually payroll (and should be included in labor expense), or if they are truly draws for personal or succession and transition purposes.
- Net herd replacement cost is calculated by the value of animals leaving the herd (cull, dairy sale or death) less any revenue received for those animals.
Cull cow prices decreased substantially from 2015 to 2016 (down $350, to $889 per cow on average). This, in turn, resulted in a jump of 33 cents per cwt in net herd replacement costs for the year, the highest in the last five years.
The top 25 percent of clients had cull cow income of $928 per cow and net herd replacement expense of $1.20 per cwt. Operations should target a value of $1.50 per cwt or less. However, a common thread among elite producers is net herd replacement costs closer to $1 per cwt.
Choosing when animals are culled and managing heifer inventories to adequately supply replacement needs can impact net herd replacement costs. Use genetic testing to make sure the heifer is genetically superior to the cow she may be replacing. Sales of extra heifers and cows provide one more alternative to increase cash sales and decrease net herd replacement cost.
- Capital costs were also up for 2016, with the benchmark average increasing 21 cents, to $2.53 per cwt. Capital costs include depreciation, interest expense and any lease payments.
The 2016 Annual Benchmark report uses management level depreciation, not tax level. How an operation is balancing the depreciation cost versus interest costs, labor efficiencies and repair costs can have a significant impact on how their operation compares.
- Overhead costs (administration, fuel, utilities, custom, etc.) decreased for the third straight year to its lowest point since 2012. Crop expenses (crop chemicals, custom hire, fertilizer, seed, land rent) were down by 16 cents cwt combined, with other expenses holding steady or having minor changes.
The decrease in crop input expenses was not enough to offset the lower value of the crops harvested, with many clients showing a loss for their agronomy enterprises.
Evaluating your balance sheet
Losses of more than $200 per cow also had a detrimental effect on the balance sheet. Owner equity decreased 4 percent and has receded pre-2014 levels, while working capital per cow dropped more than $400, the lowest in the last five years. These two measures give a straightforward overview of how your business is set up for the immediate and long-term future.
A standard target for owner equity (net worth/assets) would be 55 to 60 percent for a steady-state operation, but can dip to 45 to 50 percent in growth stages.
Working capital is current assets (cash, feed inventory, accounts receivable) less current liabilities (accounts payable, current portion, operating loans). To evaluate how well your business is structured for the near future, target a working capital level of at least $600 per cow.
This helps ensure you have the cash available to maintain cash flow and also take advantage of prepayments, cash discounts or unexpected capital purchases that can improve your operation’s efficiencies.
These two items can also offset each other – if your operation is in a comfortable owner equity position, it can withstand erosion in working capital and earnings. Conversely, a strong working capital position can insulate owner equity against deterioration in down markets.
Despite the detrimental effects of the sagging milk prices on the dairy industry, a few bright spots can be found in review of the 2016 Annual Benchmark report. There are several key items many of the top producers achieved in 2016 which allowed them to be successful.
- Develop and stick to a milk marketing plan, protecting against the lows but remaining flexible to take advantage when the market rallies.
- Maintain a strong working capital position. Be aware feed inventories can inflate working capital and can actually be a detriment to your operation. If you are maintaining a year’s worth of feed carryover, consider selling some inventory, planting more acres into cash crops or subrenting land to increase cash inflow and decrease outflow for crop inputs.
- Feed prices continue to decline in 2017. Take advantage of improved IOFC potential by maximizing milk production to achieve 6.25 pounds of butterfat and protein combined per cow per day.
- Evaluate your culling program and target less than $1.50 net herd replacement cost.
Minor adjustments can have substantial effects. Scrutinize your financials to determine key areas where you can create efficiencies and maximize opportunities for profitability on your operation.
Through diligence and high-quality management, the top 25 percent of clients in our study averaged earnings of $290 per cow, proving money can be made in a challenging milk market. 
On July 1, pending final regulatory approval, AgStar Financial Services, Badgerland Financial and 1st Farm Credit Services came together to form Compeer Financial.
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Steve Eckerman
- Business Consultant
- Compeer Financial
- Email Steve Eckerman
