Working with Dairy Working with Dairy Businesses in Businesses in

Challenging TimesChallenging Times

Kimberly, WISeptember 11, 2009

Kevin BernhardtUW-Platteville/Extension

Participant Case Study Comments:

• What is the son thinking!• What is the daughter-in-law’s education• Operation performance, yield, production• Why does the profitability look the way it does?• Family living expense / lifestyle• Condition of facilities • How much does the son want• Relationship with suppliers • Capital assets • Why is milk production dropping

ContextContext

Annual Class III Prices

02468

101214161820

1962

1965

1968

1971

1974

1977

1980

1983

1986

1989

1992

1995

1998

2001

2004

2007

Series 1

Series 1

Annual Class III

9

11

13

15

17

19Series 1

Series 1

Monthly Class III Prices

0

5

10

15

20

25

Sep

1999

Mar

200

0Se

p 20

00M

ar 2

001

Sep

2001

Mar

200

2Se

p 20

02M

ar 2

003

Sep

2003

Mar

200

4Se

p 20

04M

ar-0

5Se

p-05

Mar

-06

Sep-

06M

ar-0

7Se

p-07

Mar

-08

Sep-

08M

ar-0

9

Class III Price

Class III Price

14 18

23 19-24

Per cwt costs, prices, & income after charge for Labor/Mgt

CFFM: 101-200 cow dairies, Free stall, no organic or pasture

CDP: 100-250 Cow Dairies in WI (freestall, no pasture, not organic, cost basis of assets)

0

2

4

6

8

10

12

14

2000 2001 2002 2003 2004 2005 2006 2007 2008

ROROEROROA

5 of last 6 years ROE>ROA

CFFM Data (cost)

-10

-5

0

5

10

15

20

25

30

1996199719981999200020012002200320042005200620072008

ROROEROROA

Net Farm Income From Operations (cost)CFFM: 101-200 cow dairies, free stall, no organic, no

rotational grazingCDP: 100-250 cows, all else the same

020000400006000080000

100000120000140000

1996199719981999200020012002200320042005200620072008

CFFMCDP

WE ARE NOT WE ARE NOT ALL THE SAME ALL THE SAME

and and NOBODY IS THE NOBODY IS THE

AVERAGE!AVERAGE!

ROROE (cost basis w tax depreciation)CDP: 100-250 Cow Dairies in WI (freestall, no

pasture, no organic)

-20

-10

0

10

20

30

40

2006 2007 2008

Low 25%Middle 25%High 25%

ROROE (mrkt basis w economic depreciation)CDP: 100-250 Cow Dairies in WI (freestall, no

pasture, not organic, cost basis of assets)

-10

-5

0

5

10

15

20

25

2006 2007 2008

Low 25%Middle 25%High 25%

2008 ROROE & ROROA (cost w tax depr.)CDP: 100-250 Cow Dairies in WI (freestall, no

pasture, not organic, cost basis of assets)

-4-202468

101214161820

Low 25% Middle 25% Top 25%

ROROAROROE

2006 ROROE & ROROA (cost w tax depr.)CDP: 100-250 Cow Dairies in WI (freestall, no

pasture, not organic, cost basis of assets)

-21-18-15-12

-9-6-30369

121518

Low 25% Middle 25% Top 25%

ROROAROROE

Net Farm Income (Mrkt w. Econ Depr)CDP (same farms): 100-250 cows, freestalls, no organic,

no pasture

0

50000

100000

150000

200000

250000

300000

2006 2007 2008

Low 13%Low ThirdAverageTop 25%

Net Farm Income From Operations (cost w. Tax Depr)CDP (same farms): 100-250 cows, freestalls, no organic,

no pasture

0

50000

100000

150000

200000

2006 2007 2008

Low 13%Low ThirdTop 25%

2006 (CDP, 100-250 cows)Mrkt Value of Assets and Economic Depreciation

Performance Measure Low 25% Middle 25% Top 25%Current Ratio 2.06 12.71 3.81

Working Capital:Total Expenses 13.3% 39.84 21.8

Working Capital:Gross Revenue 12.5% 34.3 17.4

Debt:Asset 44.2% 26.9 36.9

Assets:Equity 1.79 1.37 1.59

ROROE -5.1% 3.0 11.6

ROROA -.55% 3.8 9.41

OPM -1.48% 12.1 19.8

ATO 37.0% 31.5 47.6

Interest $35,947 $29,799 $31,205

Interest:Assets 2.3 1.5 2.2

Total Assets (Mrkt) $1,561,716 $1,918,484 $1,403,604

Number of Cows 168 150 160

2007 (CDP, 100-250 cows)Mrkt Value of Assets and Economic Depreciation

Performance Measure Low 25% Middle 25% Top 25%Current Ratio 2.11 9.50 5.15

Working Capital:Total Expenses 13.9 50.7 23.2

Working Capital:Gross Revenue 12.5 39.4 17.0

Debt:Asset 37.6 24.9 32.5

Assets:Equity 1.60 1.33 1.48

ROROE .72 7.11 20.43

ROROA 2.72 7.08 15.46

OPM 8.34 20.78 25.34

ATO 32.6 34.0 61.0

Interest 44,667 35,182 29,334

Interest:Assets 2.25 1.70 1.48

Total Assets (Mrkt, ending) 1,979,979 2,067,714 1,517,532

Number of Cows 151 147 178

2008 (CDP, 100-250 cows)Mrkt Value of Assets and Economic Depreciation

Performance Measure Low 28% Middle 28% Top 28%Current Ratio 2.57 8.52 12.32

Working Capital:Total Expenses 16.6% 30.6 54.1

Working Capital:Gross Revenue 15.8% 24.9 38.6

Debt:Asset 47.5% 23.2 33.4

Assets:Equity 1.90 1.30 1.50

ROROE -3.17% 7.06 17.6

ROROA .92% 6.79 13.6

OPM 2.28% 17.02 27.6

ATO 40.4% 39.9 49.1

Interest $44,062 $29,836 $34,540

Interest:Assets 2.55% 1.35 1.8

Total Assets (Mrkt) $1,726,032 $2,202,736 $1,888,622

Number of Cows 155 172 177

2008 (CDP, 100-250 cows)Mrkt Value of Assets and Economic Depreciation

Performance Measure Low Middle TopBasic Cost:GR 69.7 59.0 52.0

Wages Paid:GR 8.3 10.4 10.3

Interest:GR 6.6 3.5 3.9

Depreciation:GR 7.8 8.4 4.7

NFIFO:GR 7.6 18.8 29.1

Milk sold per cow 18,980 21,090 21,912

SCC 234,611 208,500 213,917

Crop Acres per cow 3.0 3.0 2.4

Forage Acres per cow 1.6 1.7 1.4

Debt per cow 5,048 2,942 3,438

Net Milk Price 19.26 19.48 18.92

Cows 153 172 177

Total Assets (Mrkt ending) 1,824,600 2,202,736 1,888,622

Our Economic World Today

• Interdependent– As trading nations

• VOLATILITY• Dairy Industry structure• Energy• Technology• Interdependent

– As businesses

I’m ProcrastinatingI’m Procrastinating• What’s your mission

– Profits for bank– Satisfied and profitable customer – Reasonable risk-return

• Farm Customer Choices1.Path back to profitability (SR & LR)

• Underlying structure (finance) - Dupont• Mgt capacity (adaptability, business sense)• Personal condition (age, family help, equity, off-farm income)

2.Financially “happy” exit (Phil)

Path back to profitability may Path back to profitability may take some bridge buildingtake some bridge building

– Short Run• Debt restructuring • Increase working capital• Innovative payment arrangements

– Long Run• Financial Analysis• Partial Budgeting• Operational/Strategic alignments• Strategic and Business Planning

Is there current cash flow?(through harvest, through

Spring planting)

Is there sustainable profitability?

YES

Liquidation Liquidation SituationSituation

NO

Generate Cash Flow NO

They Cash Flow, Now is there sustainable

profitability?

YES

Liquidation Liquidation SituationSituation

NO

Financial & Management Diagnostics

-Efficiency -Efficiency-Scale -Turnings-Debt structure -Leverage-5 C’s -Character

GOGO Re-Engineer Operation

Accept & Finance Plan? YES

NO

• Are cash receipts expected to cover cash costs? • Is there some contribution to overhead?• Is current ratio 1.5 and working capital at least

enough to cover family living and debt payments– WC:GR > 20-25%

• Is Ending cash flow:All cash expenses >10%

– If Yes: Move onto next question (profitability)• Cut cash costs where possible

– Don’t throw the baby out with the bathwater.

Is there current cash flow?(through harvest, through Spring planting)

NO:

– Cut cash costs where possible – Don’t throw the baby out with the bathwater

– Outsource low return activities and sell assets– Interest only payments– Restructure and lengthen amortization– New or increased operating lines– Sale of non productive capital assets– Sale of inventory (sale and re-own)– Elimination/Sale of non profitable enterprises

Generate Cash Flow

NO:

– Investment partner– Delay new capital asset purchases– Lower family living– Off-farm employment

Generate Cash Flow

• Is ROROE at a sufficient level to meet business and family objectives?

• Is ROROE competitive with other opportunities?• Is ROROA > interest rate

– And thus ROROE > ROROA• Is the value of unpaid labor and management

covered?• Is depreciation covered?• Is a payment to equity capital covered

Is There Sustainable Profitability?

– Multiple years (trends)– Cost and market basis– Accrual– Benchmark– Search for

Where should Where should management time management time and creativity be and creativity be

targeted?targeted?

Financial & Management Diagnostics

And

Introducing the DuPont System for Financial Analysis

DuPont System• “DuPont Financial Analysis Model is a

rather straightforward method for assessing the factors that influence a firm’s financial performance.” (Gunderson, Detre, and Boehlje, AgriMarketing 2005)

DuPont System – What is It?• The system identifies profitability as

being impacted by three different levers:

1. Earnings & efficiency in earnings2. Ability of your assets to be turned into profits3. Financial leverage

Earnings

TurningsLeverage

Operating Profit Margin

Asset Turnover

Return On Assets (less interest adj.)

Financial Structure

Return On Equity

X =

X =

IncomeStream

InvestmentStream

Earnings

Turnings

Leverage

DuPont System

NFIFO – unpaid labor/mgt + interestTotal Revenue

Total RevenueTotal Assets

Return On Assets

Total AssetsTotal Equity

Return On Equity

X =

X =

Earnings

Turnings

Leverage

cash income +(-) inventory changes

cash expenses +(-) accrual exp changes + purch lstk Depr

labor + depreciation + interest expenses

OK

Too Low

OPMR

ATO OK

Too Low

Total Revenue =

Basic Costs =

Non Basic Costs =

OK

Too Low

NFIFO – unpaid labor/mgt + interestTotal Revenue

Total RevenueTotal Assets

Return On Assets

Total AssetsTotal Equity

Return On Equity

X =

X =

Earnings

Turnings

Leverage

OPMR

ATO

Too Low

OK

Too Low

OK

Too Low

- Unproductive machinery? - Buildings not being used? - Breeding livestock not producing? - Unproductive land?

NO:

• Strategic Planning• Partial Budgeting• Plan the work - work the

plan• Strategic alignments• Efficiency, Scale, Structure• Labor utilization

YES

Is There Sustainable Profitability?

GOGO

Re-Engineer Operation

Accept & Finance Plan?

NO YES

Re-Engineer Operation

Liquidation Liquidation SituationSituation

What Else?What Else?• Reduce Risk

– Loan Guarantee Programs– Marketing– Production– Fixed interest rates (secondary market)– Insurance checkup– Labor– Health

• Sensitivity Analysis

5 C’s5 C’s• Collateral

– yes, but!• Conditions

– What is the loan for?• Capacity• Capital • Character

– Not a computational task!

Be CreativeBe Creative• Is it better to stick to your rules and

policies, or find a way to get some money back?

• Good managers in bad situations could be good future & profitable customers

• How can you minimize losses

Banker on Management Banker on Management Team?Team?

There is a reason they There is a reason they put a human behind the put a human behind the lenders desk and it’s not lenders desk and it’s not for when times are good for when times are good

FinallyFinally