Tom Kriegl, University of Wisconsin Extension and Center for Dairy Profitability agricultural economist, says if a family is realistic, they can usually figure out within 10 or 15 minutes where their farming operation falls on the profitability chart.
If you have read over the profitability chart and determined your farm is not in the top three levels, you’re not alone.
• Tom Kriegl, Center for Dairy Profitability, has developed a profitability scale.
• Farmers can gauge where their farm businesses fit on this scale.
• Most Wisconsin dairy farms had a tough year in 2009.
“Levels 8 to 10 should be the goal [especially when entering the farm business], although few farms consistently achieve levels 9 or 10,” Kriegl says.
“We didn’t have very many Level 8 or Level 9 dairy farmers in 2009, and it doesn’t look like we’ll have a lot in 2010,” he notes.
“Many farms move between levels 5, 6, 7 and 8 from year to year, with variations in weather, price and other factors,” Kriegl says. “But most farms do have a level at which they typically operate more than at any other level. The future in the dairy industry is not bright for anyone who spent much time at Level 6 or lower in 2007 or 2008, because they will likely be lower in bad years.”
The more farmers relax their standard of profitability below economic profit (Level 10), the greater the risk they assume and the easier it is to fall to the next level. The lower the level of profitability, the faster the business and family can move in the wrong direction.
“Those who find themselves at Level 6 or lower owe it to themselves and their family to seek financial advice soon. Of course, farm families above Level 6 can also benefit from financial advice, and often do,” Kriegl says.
At Level 5 or lower, improvement is difficult. “Unfortunately, transitioning out of farming while maintaining equity may be a more realistic goal for those who are frequently at Level 5 or below,” he says.
Kriegl says if your farm is at one of the exit levels, you may not need to sell everything. “Maybe they just need to sell the cows and machinery and rent the farm out. Rent values are fairly attractive, and if one or both spouses can find a job — that’s a big ‘if’ today — maybe it will work out.”
Many farm families have a number of non-business goals that interfere with maximizing profitability. This isn’t necessarily bad, but too often the level of profitability that farm families are willing to accept places them under great risk, not only of falling short of business goals, but also of falling short of personal goals of improved family living and security. According to Kriegl, financial analysis can help farm families understand the price they pay for the choices they make.
“When times are tough — when commodity prices are low, when there is drought or a shortage of feed, for example — farmers often ask: ‘What are the most profitable practices under these conditions?’ The answer usually disappoints those who ask it, because practices that maximize profitability when times are good are the same practices that help maximize profits [or in many cases, minimize losses] when times are tough,” he explains.
“I think this surprises people because when times are good, one can achieve a satisfactory profit level without using all of the profit-maximizing practices,” Kriegl says. “When times are good and profit margins are generous, people may become complacent and adopt practices that seem convenient or appealing even though the practices reduce profitability. When these practices become routine, it is easy to think of these less-profitable practices as essential.”
It’s also important to recognize that the components of a practice that contributes to profitability can change.
“For example, feeding the least cost balanced ration is a practice that helps maximize profits or minimize losses under all conditions except one: when revenue fails to equal or exceed variable cost,” Kriegl says. “However, the components of the least cost balanced ration can vary radically as prices of the ingredients and the product change.
“We must also recognize that tools that maximize profit can be underused. For example, feed testing, milk testing, soil testing, and recordkeeping and analysis are all tools that can help maximize profits. Yet, some managers pay for these tools but ignore the information these tools provide. Misusing or not using such tools will actually detract from profitability.”
The practices and tools that contribute to profitability are similar in both good economic times and bad, he says. However, the way managers implement these practices and tools may change.
Timing is important
Kriegl says timing greatly influences financial success. “If you bought your farm in the 1960s or 1990, you had a greater chance of being successful than if you bought in 1980 or in 2008,” he notes.
“Most farmers couldn’t win in 2009. Milk prices were below the average cost of production. Without daily profitability, liquidity quickly evaporated, requiring farmers to use solvency [equity], forcing them lower on the profitability scale,” Kriegl adds. “A lot of equity was eroded on dairy farms in 2009. The dairy farms whose timing allowed them to begin 2009 with a lot of equity and little debt were more able to weather the storm.”