A Study into Dairy Profitability MSC Business Services during

Transcription

1 A Study into Dairy Profitability MSC Business Services during July 2010 Authors: Michael Evanish, Manager Wayne Brubaker, Consultant Lee Wenger, Consultant Page 1 of 43

2 Page 2 of 43

3 Index Part 1: Reason for this Study... 4 Part 2: Methodologies... 4 Part 2.1: The MSC Business Services Analysis... 4 Part 2.2: About the Farms... 5 Part 2.3: The Selection Process... 5 Part 2.4: Location & Size of the Farms... 6 Part 3: Findings... 6 Part 3.1: Financial Profiles... 6 Part 3.2: Financial Profile Conclusions Part 3.3: Operator Profile Part 3.4: Net Margin Results Part 3.5: Revenue Results Part 3.6: Expense Results Part 3.7: How do the Study Group Farms Out-Perform the Average Farms? Part 3.8: Study Group Production Part 3.9: Cows and Profits Part 3.10: Labor Efficiencies Part 4: Conclusions Part 4.1: Revenue Part 4.2: Expenses Part 4.3: Other Factors Part 5: Final Word Page 3 of 43

4 Part 1: Reason for this Study Prices paid to producers in recent years have become more volatile with Class III prices as low as $9.31 and as high as $21.38 per Hundredweight (CWT) ( This is more than a 100% swing from low to high. Given this volatility, the vast majority of producers making use of the MSC Business Services Business Analysis program lost money in 2006 and Only during the relatively high milk price years of 2007 and 2008 did the majority experience profitability. Even in 2007 and 2008, when milk prices were higher, profitability was limited due to high feed costs and other sharp input cost increases. With the extreme price and cost volatility some producers were profitable in all 4 years. This study attempts to identify the management practices of these farms, compared to those of average farms. Part 2: Methodologies Part 2.1: The MSC Business Services Analysis The MSC Business Services Analysis contains an accrual based Compilation Report and Management Study. While cash basis records are the starting point for the collection of data, these cash records are adjusted by all necessary accruals so that the resulting statements are accrual statements. For the Management Study and the Income Statement, Economic Depreciation is used. To use Tax Depreciation would result in a distortion due to the use of Section 179, bonus depreciation and other tax depreciation rules. The goal of using Economic Depreciation is to base depreciation on the actual useful life of assets. Economic Depreciation is based on the farmer s estimated fair market value of his equipment. Finally, for the Management Study, a charge is made for Management Labor for sole proprietorships and partnerships. This charge represents a best estimate of the fair labor value for the owner/manager(s) and brings non-corporate businesses onto the same playing field as corporate businesses. All business types can now be fairly compared. Page 4 of 43

5 Part 2.2: About the Farms Of the nearly 2,000 Business Analysis prepared each year, approximately 800 are dairy farms and of those about 500 are included in this study. Farms are excluded for a multitude of reasons ranging from expansion, entity type changes, family health issues, admission of new partners, windfalls of cash that distort results, unwillingness of the producer to supply all needed information, and more. The MSC Business Services Business Analysis is provided on an annual basis to all clients and is used as a starting point for improving profitability, transition planning, paperwork requirements of bankers and more. Because it is used for selfimprovement, we believe it represents data that are as accurate as is possible to obtain. No additions or subtractions to the original data were made while conducting this study. Part 2.3: The Selection Process While pulling summaries for use by staff in going over the Business Analysis with producers, it was noted that nearly 19% of the Dairy Management Studies (85 of 455) reported a positive Net Margin (profit) for Reporting an accrual profit, in a year recognized as one of the worst of all time for dairy farmers, is a remarkable achievement and these farms represented our initial group of top performers. One year does not a trend make, so it was decided that the farms selected for the Study Group must meet all of the following: - Be profitable in all years 2006 through Must have been using MSC Business Services and received a Business Analysis in years 2006 through Must have provided accurate and complete information for years 2006 through 2009 and not experienced an extraordinary event that skewed the data. The measurement of profit used was Net Margin per CWT. Net Margin is the result of Accrued Revenue less all Accrued Expenses (including Economic Depreciation and a Management Labor charge). We used Net Margin per CWT, rather than Net Margin per cow, because in our view it more accurately takes all factors into account (milk production per cow matters when measuring profitability). Page 5 of 43

6 Part 2.4: Location & Size of the Farms The 24 farms that make up the Study Group come from many regions of PA. The map reports the PA Farm Bureau regions of the state and the number of farms in the Study Group in each region. Measuring the size of the 24 farms over the 4 years being studied was difficult, as all grew their cow numbers over the period. The average size of the farms, measured by average number of cows milked, broke down with 15 being smaller than 150 cows and 9 being larger than 150. The smallest average number of cows milked was 62 while the largest was 365. The 24 farms in the Study Group averaged milking 164 cows for the study period, while the Average Farms averaged 120 cows milking. Part 3: Findings Part 3.1: Financial Profiles What is the Financial Profile of the Study Group compared to the Average Farms? We looked at the following areas for comparison: - Return on Assets - Assets per Cow - Return on Equity - EBITD per Cow - Interest per Cow - Depreciation per Cow - Percent Net Worth - Dairy Debt per Cow Page 6 of 43

7 Return on Assets - We calculate Return on Asset (ROA) as follows: (Net Income before Accrued Taxes Management Labor +Interest Expenses) /Total Avg Market Assets. The table below shows the averages of the Study Group vs. the Average Farms. Return on Assets Study Group 3.23% 9.08% 11.91% 5.59% 7.45% Average Farms -3.59% 1.94% 4.99% -0.66% 0.67% Difference 6.82% 7.14% 6.92% 6.25% 6.78% The Study Group averaged a 7.45% ROA and the Average Farms averaged 0.67%, for a difference of 6.78%. The Study Farms generated a rate of return nearly eleven times greater than the Average Farms. This is a significant difference. It is possible this difference was due to the Average Farms having more assets, because based on a given amount of profit, the greater the Market Value of Assets the lower the rate of return. To determine how the Market Basis Value of Assets compared, we looked at the Assets per Cow of each group. Assets per Cow Study Group $12,857 $12,418 $12,008 $10,395 $11,920 Average Farms $,13,579 $13,757 $13,014 $12,262 $13,153 Difference -$722 -$1,339 -$1,006 -$1,867 -$1,233 There is a variation in average Assets per Cow of $1,233. This approximately 10% difference in asset value results in an approximately 1% change in ROA and is simply not large enough to be the reason for the ROA difference. This relatively small difference leads to the conclusion that the difference in ROA is due mostly to the increased profitability of the Study Group farms. Page 7 of 43

8 Return on Equity - We calculate Return on Equity (ROE) as follows: (Net Income before Accrued Taxes Management Labor) / Average Market Equity. The averages for Return on Equity are shown below. Return on Equity Study Group 3.87% 13.29% 18.73% 7.47% 10.84% Average Farms % % 5.58% -7.63% -9.45% Difference 14.84% 38.05% 13.15% 15.10% 20.29% The Average Farms averaged a ROE of -9.45%, compared to a ROE of 10.84% for the Study Group. ROA adds the interest expense back in, whereas ROE does not. The higher debt of the Average Farms (discussed later) is part of the reason for the significant difference of 20.29% between these two groups. The other reason would be greater profitability as discussed under the ROA. How does equity influence this return? Equity per Cow Study Group $8,659 $8,179 $7,721 $6,637 $7.799 Average Farms $7,789 $7,991 $7,748 $7,273 $7,700 Difference $870 $188 $-27 -$636 $99 There is little difference in the Equity per Cow between these groups of farms. Once again, as with ROA, the superior performance is due to profit. It is interesting that the Study Farms increased their Equity per Cow each year of the study, including 2009, while the Average Farms saw a decline in Equity per Cow in Page 8 of 43

9 Earnings before Interest, Taxes, Depreciation / Cow - We calculate Earnings before Interest, Taxes, Depreciation (EBITD) per Cow as follows: (Net Income before Accrued Taxes + Interest + Depreciation) / Average Number of Cows. EBITD is an indicator of the farm s profit without ownership costs. The table below shows these averages. Earnings before Interest, Taxes, Depreciation/Cow Study Group $1,055 $1,644 $1,915 $1,173 $1,447 Average Farms $523 $1,133 $1,421 $817 $974 Difference $532 $511 $494 $356 $473 The average difference between the two groups is nearly $500 per Cow. This is significant in that the Study Group has almost 1/3 more income available to cover their interest, taxes and depreciation. The Study Group is much better equipped to repay debt, and, due to greater earnings, is less likely to need help meeting cash flow needs. In addition, this demonstrates the Study Group s ability to generate profits from their operations. Further, the gap between these two groups has widened each year on the study. This indicates that not only are the farms in the Study Group more profitable on average, they are increasing their advantage, as time moves on. The Study Group not only generates more EBITD, they also have an advantage with interest and depreciation expenses. The averages for Interest and Depreciation per Cow are shown in the tables that follow. Interest per Cow Study Group $64 $77 $88 $92 $80 Average Farms $182 $167 $194 $174 $179 Difference $(118) $(90) $(106) $(82) $(99) Page 9 of 43

10 Depreciation per Cow Study Group $261 $249 $231 $220 $240 Average Farms $320 $306 $281 $280 $297 Difference $(59) $(57) $(50) $(60) $(57) Interest and Depreciation per Cow alone, reduce costs by $156 per Cow. Add this difference to the EBITD/Cow difference of $473 per Cow, and the Study Group operates at a $629 per Cow profit advantage. Percent Net Worth is the relationship between the farmer s Equity and his Total Assets. The table below shows this relationship for each of the groups. Percent Net Worth Study Group 66% 64% 63% 62% 64% Average Farms 54% 55% 56% 56% 55% Difference 12% 9% 7% 6% 9% The Study Group has a higher Net Worth by 9%. This is somewhat significant but is not the biggest factor in determining their profitability advantage. The most stunning fact in this information is that the Study Group increased their Net Worth Percentage every year, while in two of the four years the Average Farms Net Worth actually decreased. This shows that the additional profitability of the Study Group is impacting their financial position. The calculation for Net Worth includes a deferred liability for Deferred Income Taxes on the appreciated farm assets. Deferred Income Taxes do not have to be paid with income from the operation but will be paid if some future event (the sale of the assets) occurs. Deferred Income Taxes may skew the Net Worth of any business, especially if the business has a relatively low tax basis for its assets. A low tax basis can be caused Page 10 of 43

11 by aggressive tax depreciation deductions or a low purchase price of appreciated assets such as land. Therefore, we looked at the Dairy Debt per Cow (the debt of the farm without Deferred Taxes taken into account) to look more clearly at the actual debts the farms must pay out of their operating income. This information is below. Dairy Debt per Cow Study Group $1,357 $1,453 $1,504 $1,502 $1,454 Average Farms $3,062 $2,948 $2,605 $2,699 $2,829 Difference $(1,705) $(1,495) $(1,101) $(1,197) $(1,375) The data show similar results as the Net Worth Percentage. The Study Group is generally reducing debt, while the Average Farms are increasing debt. Part 3.2: Financial Profile Conclusions Much has been written about the relationship of cash flow to sustainability, about just how important it is, and, we believe this to be true. It has long been assumed that so long as it Cash Flows, it will be OK. It is also true that while a business may Cash Flow, higher debt will lead to greater stress in down years. These profiles indicate that the true driver of financial health rests in the profitability of the farm. The greater the profitability of a farm, the greater the survivability of that farm. Successful farms manage debt; they control debt instead of debt controlling them. The Average Farms have 48.6% more debt than the Study Group. This additional debt is a result of lower profitability over a period of time. This additional debt makes it much harder on the Average Farms to remain Cash Flow Positive during the down years. Page 11 of 43

12 Part 3.3: Operator Profile As an operation matures it should have less debt, as the operator prepares for retirement. It is generally thought that the amount of debt obligation carried by a farm is directly related to the age of the farmer. To determine if the Study Group was older than the Average Farms, we looked at the average age of the youngest member of the ownership team of both groups. The average age of the Study Group was 47 years, while the comparable age for the Average Farms was 50. The Study Group has younger members in the business than does the Average Farms Group. This may also indicate that the Study Group has more multi-generational farms than the Average Farms. Our data do not contain information specifically related to answering this question. The only piece of data that provides insight is the entity type of each farm. We collect whether the farm is a sole proprietorship, partnership or corporation. 67% of the Study Group are sole proprietors while 73% of the Average Farms are sole proprietors. By definition, a sole proprietor cannot be a multigenerational farm. Therefore, the age of the youngest owner is that of the owner himself. 33% of the Study Group have the potential to be multigenerational farms because they are partnerships, while 27% of the Average Farms have the same potential. Because of the size of the Study Group, a shift of two farms from a partnership to sole proprietorship would make the percentages equal. Taking this into account, it appears there is no significant difference in the form of business of the two groups. We conclude from these profiles that the Study Group is not a group of older farms that have had many years to reduce Debt and increase Net Worth. The two groups are of similar age and business structure. The major difference in these farms is their ability to generate a profit, which allows them to better manage debts. Page 12 of 43

13 Part 3.4: Net Margin Results Since we used Net Margin per CWT to define the Study Group, it would follow that they had a higher Net Margin per CWT than the Average Farms. The following chart shows how the Average Farms compared to the Study Group farms. Net Margin per CWT Study Group $1.40 $3.79 $5.02 $1.94 $3.04 Average Farms $(2.51) $0.50 $2.27 $(0.78) $(0.13) Difference $3.91 $3.29 $2.75 $2.72 $3.17 Looking more closely at this information discloses some interesting comparisons. The Study Group Farms averaged $3.17 per CWT more profit than the Average Farms. The difference increased each of the four years of the study. Differences in Net Margin are always a function of differences in Revenue, Costs or a combination of both. If Revenues are higher, it is easy to follow that the Net Margin should be higher. Conversely, if Costs are higher, Net Margin would be lower. Part 3.5: Revenue Results Revenue from Milk Sales is the main source of income on a dairy farm. The amount of Revenue is a function of Milk Price per CWT and pounds of milk produced (discussed later). Was there any difference in the price received between the Study Group and the Average Farms? The following table explores the Milk Price per CWT received by each group. Page 13 of 43

14 Milk Price per CWT Study Group $13.87 $19.74 $20.44 $14.23 $17.07 Average Farms $13.92 $19.84 $20.52 $14.35 $17.16 Difference $(0.05) $(0.10) $(0.08) $(0.12) $(0.09) This analysis indicates that the Study Group actually received a lower price for their milk in each year of the study. However, we believe the difference of $0.09 is insignificant. Butterfat % and Protein % differences could easily explain this difference. Butterfat % Study Group 3.73% 3.71% 3.69% 3.68% 3.70% Average Farms 3.78% 3.78% 3.70% 3.73% 3.75% Difference (0.05%) (0.07%) (0.01%) (0.05%) (0.04%) Protein % Study Group 3.06% 3.06% 3.05% 3.05% 3.06% Average Farms 3.08% 3.09% 3.08% 3.06% 3.08% Difference (0.02%) (0.03%) (0.03%) (0.01%) (0.02%) Much has been written about, and considerable time devoted to, maximizing the positive revenue effects of higher Butterfat and Protein Percentages. An interesting finding is that the farms in the Study Group had lower percentages of both. These lower percentages resulted in the lower milk price per CWT received by the Study Group. Page 14 of 43

15 They also lead to the conclusion that these most profitable farms concentrate primarily on other aspects of the dairy business in the search for profits. The second source of Income we looked at was Livestock Income. Livestock Income is calculated by adding calf sales, cull cow sales, dairy livestock sales to any change in livestock inventory and subtracting any livestock purchased. The table below shows these results for Livestock Income per CWT. Livestock Income per CWT Study Group $1.27 $1.12 $1.40 $1.28 $1.27 Average Farms $0.92 $0.93 $0.88 $0.98 $0.93 Difference $0.35 $0.19 $0.52 $0.30 $0.34 It appears that the Study Group has a significant advantage in Livestock Income per CWT. While the Average Farms generated $0.93 per CWT, the Study Group generated $1.27 per CWT, a clear advantage of over 36%. This can be a result of additional animals sold, fewer animals purchased, or livestock inventory increases. This led us to examine Livestock Sold per CWT as we looked for the reason for this advantage Livestock Sold per CWT Study Group $0.89 $0.95 $0.96 $1.18 $1.00 Average Farms $0.80 $0.97 $0.90 $1.08 $0.94 Difference $0.09 $(0.02) $0.06 $0.10 $0.06 There is a slight advantage in livestock sold, but it is small. Further, it does not follow a consistent pattern. On average, the Study Group can count on about $0.06 per CWT extra Revenue from livestock sales. Page 15 of 43

16 This could be the result of a difference in Livestock Inventory Change per CWT or Livestock Purchases per CWT. Livestock Inventory Change per CWT Study Group $0.37 $0.19 $0.54 $0.23 $0.33 Average Farms $0.27 $0.16 $0.22 $0.17 $0.21 Difference $0.10 $0.03 $0.32 $0.06 $0.12 Livestock Purchases per CWT Study Group $0.02 $0.02 $0.11 $0.14 $0.07 Average Farms $0.24 $0.31 $0.31 $0.40 $0.32 Difference $(0.22) $(0.29) $(0.20) $(0.26) $(0.25) The Study Group had a slight advantage when comparing Livestock Inventory Growth. This inventory growth has about double the impact of Livestock Sold. The MSC Business Analysis makes use of Standard Values for Livestock that have been unchanged throughout the study period. This means the inventory increase reported above represents additional dairy animals on hand. The biggest difference in Livestock Income per CWT is in the dollars spent to maintain or increase herd size. The Study Group farms spent $0.25 per CWT less for replacement animals, sold an additional $0.06 per CWT, and grew their herd by an additional $0.12. This $0.43 difference is significant. Clearly the Study Group is doing a better job producing income from selling or raising their animals. It is common to sell excess crops, and Government Payments can play a significant role in generating Revenue. The tables below explore the differences in Crop Sales and Government Payments. Page 16 of 43

17 Crop Sales per CWT Study Group $0.51 $0.40 $0.44 $0.25 $0.40 Average Farms $0.34 $0.44 $0.51 $0.53 $0.46 Difference $0.17 $(0.04) $(0.07) $(0.28) $(0.06) Government Payments per CWT Study Group $1.34 $0.24 $0.18 $0.69 $0.61 Average Farms $1.25 $0.23 $0.25 $0.80 $0.63 Difference $0.09 $0.01 $(0.07) $(0.11) $(0.02) In the areas of Crop Sales and Government Payments per CWT, the Study Group and the Average Farms report no material difference. It is interesting to note that in both cases the Average Farms received more Revenue. How does Total Revenue per CWT compare for the two groups? Total Revenue per CWT Study Group $17.37 $22.06 $22.87 $16.84 $19.79 Average Farms $16.98 $22.05 $22.82 $17.35 $19.80 Difference $0.39 $0.01 $0.05 $(0.51) $(0.01) The $0.01 difference in Total Revenue per CWT between the groups is insignificant. The Study Group appears to have no distinct advantage as a result of Revenue. The Average Farms make up for the entire Livestock Income advantage of the Study Group through added sources of Revenue. Page 17 of 43

18 Conclusion - The overall difference in Revenue per CWT is insignificant. If there is any advantage with the Study Group over the Average Farms, it is in Livestock Income. Much of that comes from the additional money spent by the Average Farms on purchasing livestock to maintain herd size. The simple fact that the Study Group does not have to rely on other Revenue sources to the extent that the Average Farms do, is an important clue into their profitability. Could it be that the Study Group does a better job of focusing on the animals and that results in less of a need to look for other income? Part 3.6: Expense Results When studying farm profitability on the Management Study, we break expenses into: - Interest Costs, - Sales & Administrative Costs, and - Production Costs. It is often thought that the most profitable farms do not pay interest. Therefore, they have an advantage in profitability. We began our study of farm expenses by looking at Interest Cost per CWT. Here are our findings. Interest Cost per CWT Study Group $0.28 $0.34 $0.40 $0.42 $0.36 Average Farms $0.79 $0.85 $0.93 $0.84 $0.85 Difference $(0.51) $(0.51) $(0.53) $(0.42) $(0.49) The results are significant in that there is a $0.49 per CWT advantage of the Study Group over the Average Farms. One interesting note is that the Interest Cost has continued to go down in each year of study for the Study Group. They generate Cash Flows and Profits that are great enough to continue to pay down debt even in the worst years. Page 18 of 43

19 The Average Farms, on the other hand, increased interest cost in one of the best year s dairy has seen: Not a good trend. Another interesting point taken from this information is the percentage of milk sales interest costs represent. In the Study Group, interest represents only 2% of milk sales. For the Average Farms, interest represents 5% of total sales. The Average Farms spend 150% more on interest than the Study Group, but the overall percentage of milk dedicated to interest is relatively small in both cases. This confirms our earlier conclusion that the Study Group has the ability to service debt more effectively due to increased profits. The Study Group also consistently reduces debt. In addition, while the Average Farms pay more interest, the overall impact of interest to profit is small due to the percent of milk income dedicated to interest. The $0.49 per CWT represents only 15% of the difference in profit. What about Sales & Administrative Costs per CWT? Sales and Administrative Costs include those costs that are not directly related to production. They include Milk Marketing Expenses (milk check deductions), Insurance, Taxes, Management Labor, Economic Depreciation and any other non-production expenses incurred by the farm. Sales & Administrative Costs per CWT Study Group $4.73 $4.93 $4.79 $4.47 $4.73 Average Farms $5.43 $5.49 $5.35 $5.23 $5.38 Difference $(0.70) $(0.56) $(0.56) $(0.76) $(0.65) The difference of $0.65 per CWT is a significant advantage. A closer look at what makes up the major expenses in this area should provide greater insight. Page 19 of 43

20 Milk Marketing Expenses are the costs to take milk from the farm to market and other required deductions. It includes: Hauling, Coop Dues, Advertising, CWT deductions and other deductions from the farm s milk check. Milk Marketing Expenses per CWT Study Group $0.99 $1.01 $0.90 $0.87 $0.94 Average Farms $1.01 $1.00 $0.93 $0.88 $0.95 Difference $(0.02) $0.01 $(0.03) $(0.01) $(0.01) There is no significant difference in overall Milk Marketing Expense, as both groups incur approximately the same cost getting their milk to market. Other Sales & Administrative Expenses include Insurance Expenses and Real Estate Taxes. Insurance Expense per CWT Study Group $0.31 $0.35 $0.34 $0.30 $0.33 Average Farms $0.38 $0.41 $0.42 $0.41 $0.41 Difference $(0.07) $(0.06) $(0.08) $(0.11) $(0.08) The Study Group has a slight advantage in Insurance Expense. Much of this difference can be explained by the increased milk production (discussed later) in the Study Group. This difference is insignificant. Page 20 of 43

21 Real Estate Taxes per CWT Study Group $0.19 $0.17 $0.16 $0.15 $0.17 Average Farms $0.23 $0.23 $0.24 $0.23 $0.23 Difference $(0.04) $(0.06) $(0.08) $(0.08) $(0.06) Here, as with Insurance, there are insignificant differences; the increased milk production of the Study Group would explain much of the difference. Management Labor is the largest of the Sales and Administrative Costs. The table below shows this expense. Management Labor per CWT Study Group $1.92 $2.10 $2.18 $1.99 $2.05 Average Farms $2.14 $2.23 $2.25 $2.19 $2.20 Difference $(0.22) $(0.13) $(0.07) $(0.20) $(0.15) Most of this difference, again, can be explained by the increased milk production of the Study Group. Depreciation is the last expense we will look at in Sales and Administrative Costs. As explained earlier, we calculate an Economic Depreciation. The table shows the impact of depreciation expense. Page 21 of 43

22 Depreciation Expense per CWT Study Group $1.15 $1.12 $1.05 $1.00 $1.08 Average Farms $1.51 $1.43 $1.34 $1.35 $1.41 Difference $(0.36) $(0.31) $(0.29) $(0.35) $(0.33) Depreciation accounts for more than half of the Study Group s reduced Sales and Administrative Costs. This is significant. What causes this difference? It appears that the Average Farms have committed larger amounts to capital. They have more machinery and buildings. This may show a preference of the Average Farms for more and/or newer equipment and help explain the greater Assets per Cow, greater debt and higher interest costs studied earlier. We determined that 64% of the Average Farm s depreciation came from equipment, while 60% of the Study Group s depreciation came from equipment. The Study Group spent an average of $0.65 per CWT on equipment depreciation while the Average Farms spent $0.90. The Average Farms have more money invested in equipment per CWT. Does the Average Farm purchase more equipment? We compared the equipment purchased in each of the 4 years. The following tables show the Equipment Purchases per Cow and CWT. Equipment Purchased per Cow Study Group Average Farms Difference $182 $435 $313 $174 $276 $144 $382 $331 $220 $269 $38 $53 $(18) $(46) $7 Page 22 of 43

23 Equipment Purchased per CWT Study Group Average Farms Difference $0.80 $1.94 $1.43 $0.79 $1.24 $0.68 $1.79 $1.58 $1.06 $1.28 $0.12 $0.15 $(0.15) $(0.27) $(0.04) Over the past 4 years there was no significant difference in the amount of equipment the two groups purchased. Therefore, at least in the study years, the difference in the depreciation expense appears to be a result of the way the Study Group values their equipment. They believe it to be worth somewhat less. The Average Farms do have more Crop Acres per Cow (discussed later) than the Study Group. Is it possible that they need better equipment to farm the additional acres? To determine if this is true, we looked at Depreciation per Acre. Here are the findings. Depreciation per Acre Study Group $60 $56 $52 $51 $55 Average Farms $81 $81 $66 $66 $74 Difference $(21) $(25) $(14) $(15) $(19) The Average Farms averaged $19.00 more depreciation cost per acre. The greater value of equipment that the Average Farms own results in greater depreciation cost per acre. With increased investment in equipment one would expect that the Average Farms would have lower Machinery Operating Costs per CWT due to owning more valuable equipment. Machinery Operating Costs include machinery repairs, fuel, vehicle expense, and machine hire expense less custom work income, less Gas Tax Refunds. What do the data show? Page 23 of 43

24 Machinery Operating Costs per CWT Study Group $1.59 $2.18 $1.86 $1.59 $1.80 Average Farms $1.93 $2.63 $2.33 $1.96 $2.21 Difference $(0.34) $(0.45) $(0.47) $(0.37) $(0.41) The data show a significant increase in Machinery Operating Costs per CWT for the Average Farms. One distinct difference in these two groups of farms is the Study Group s ability to maintain lower cost to operate their equipment. In addition, the Average Farms increased their spending in years when milk prices were high. This may show a propensity of the Average Farms to spend to their income instead of spending to their needs. Conclusion - Savings from lower Interest Cost and lower Sales & Administrative Costs represent 36% of the profit difference between the two groups. That leaves 64% of the difference that must come from Production Costs. Production Costs are the most controllable of all costs in any operation. Therefore, one of the key differences between the Study Group and the Average Farms is their ability to manage their controllable Cost of Production per CWT. Total Production Costs per CWT Study Group $11.29 $12.74 $12.16 $10.12 $11.58 Average Farms $13.28 $15.19 $14.27 $12.05 $13.70 Difference $(1.99) $(2.45) $(2.11) $(1.93) $(2.12) For the Average Group, there was a difference in Total Production Costs per CWT of $3.14 from the highest cost year to the lowest cost year. The Study Group farms had a difference of $2.64. The $0.50 difference represents a significant cost control advantage. Page 24 of 43

25 The Study Group farms are better able to manage their controllable costs. For the Study Group to hold the line on expenses in an environment of quickly rising costs, required knowledge of the situation and a willingness to make the necessary changes. Part 3.7: How do the Study Group Farms Out-Perform the Average Farms? On a dairy farm it all begins with Milk Sold per Cow. Milk Sold per Cow Study Group 21,899 21,592 21,276 21,323 21,523 Average Farms 19,862 20,113 19,758 19,669 19,850 Difference 2,037 1,479 1,518 1,654 1,673 The Study Group farms increased the gap in production in the years with the lowest prices. They understand they must maintain or increase production even if the price is not good. Actions taken by the Average Farms resulted in reduced production in the lean years. Maintaining and improving production may be one of the traits that set the Study Group farms apart from the others. They understand that increased Production per Cow has an impact on the Cost of Production and Profits. If the Average Farms in 2009 had produced the same amount of milk per cow as the Study Group, they would have realized an additional $34,309 of Revenue (2,037# 121 $13.92 per CWT). Additionally, they would have reduced their Total Costs per CWT by $1.05 (see the table that follows). Page 25 of 43

26 The first three columns reflect the information on the 2009 Average Farms Summary. In the last three columns the only change is the increase in milk sold due to a 2,037 pound increase in milk production. This changes the total Feed, Crop and Milk Marketing Costs. All other costs remain the same and are divided over more CWTs of milk. The Average Farms could have reduced Production Costs by $0.59, Interest Costs by $0.07 and Sales & Administrative Costs by $0.39 per CWT, if they had produced the same amount of milk as the Study Group. Actual 2009 Per Cow $ Cow Numbers ,037# more Production Per CWT Per Cow $ Per CWT Milk Sold 2,570,717 2,817,194 Milk Income $2,957 $357,797 $13.92 $3,241 $392,153 $13.92 Feed $1,092 $132,132 $5.14 $1,197 $144,801 $5.14 Crop $298 $36,058 $1.40 $298 $39,515 $1.40 Marketing $215 $26,015 $1.01 $215 $28,509 $1.01 Other Production Costs / Cow $1,430 $173,030 $6.73 $1,430 $173,030 $6.14 Production and Milk Marketing Costs $3,035 $367,235 $14.29 $3,140 $385,855 $13.70 Interest Cost $167 $20,207 $0.79 $167 $20,207 $0.72 Administrative less Marketing Costs $938 $113,498 $4.42 $938 $113,498 $4.03 Total Costs $4,140 $500,940 $19.49 $4,245 $519,560 $18.44 Net Margin $(1,183) $(143,143) $(5.57) $(1,004) $(127,407) $(4.52) There is very little impact on Interest Costs since those costs are such a small portion of the Total Costs. The greatest impact is on Production Costs and non-milk Marketing Administrative Costs. Page 26 of 43

27 Part 3.8: Study Group Production Increases in production may be a result of better udder health. A great measure of overall udder health is Somatic Cell Counts. Somatic Cell Counts (SCC) Study Group 237, , , , ,000 Average Farms 280, , , , ,000 Difference (43,000) (55,000) (51,000) (47,000) (49,000) The Study Group had a lower SCC by 49,000. The following information on the effects SCC has on production was taken from Wikipedia on June 8, The entry shows the production impact of SCC. Extrapolating this to our difference, the Average Farms lost approximately one percent (1%) of milk production due to SCC. As a result there is a loss of approximately 200 pounds of milk per cow due to the higher SCC for the Average Farms. The increased SCC, while playing a role, is relatively insignificant in explaining the production differences. As discussed in the paper Guidelines for Using the DHI Somatic Cell Count Program [4] The results of many studies suggest that cows with SCC of less than 200,000 are not likely to be infected with major mastitis pathogens, but cows with SCC above 300,000 are probably infected (Smith, 1996). Herds with bulk tank SCC above 200,000 will have varying degrees of subclinical mastitis present. Data from the National Mastitis Council (1987) show that 6% of the [udder] quarters in a herd could be expected to be infected in a herd with a bulk tank SCC of 200,000. At 500,000 SCC, 16% of the quarters may be infected with a 6% reduction in milk production compared to a SCC of 200, Source used by Wikipedia ^ Guidelines for Using the DHI Somatic Cell Count Program, Author: G.M. Jones, Professor of Dairy Science and Extension Dairy Scientist, Milk Quality & Milking Management, Virginia Tech, Publication Number , posted March Page 27 of 43

28 Feed costs can also drive an increase in production. In an attempt to account for variations in the amount of feed grown on the farm vs. the feed purchased, we looked at Purchased Feed Costs and Crop Costs per CWT. This ratio includes the purchased feed and crop expenses pitted against the milk production. Specifically, crop expense is the direct crop expenses which includes fertilizer, seed and chemicals only. Purchased Feed & Crop Costs per Cwt Study Group Average Farms Difference $5.44 $7.65 $7.05 $5.46 $6.40 $6.66 $11.65 $11.35 $9.39 $9.76 $(1.22) $(4.00) $(4.30) $(3.93) $(3.36) There is a significant difference of $3.36 per CWT between the Study Group and the Average Farms. Purchased feed includes an accrual adjustment for changes in feed inventories. It is possible that the lower feed costs are a result of substantial increases in inventories. The table below shows the impact of the inventory changes on Purchased Feed Costs. Change in Inventory per CWT Study Group Average Farms Difference $0.13 $0.34 $0.04 $0.30 $0.20 $(0.01) $0.30 $0.01 $0.18 $0.12 $0.14 _$0.04 $0.03 $0.12 $0.08 While the difference in the change in inventory favors the Study Group, it is insignificant as a contributor to the total difference in the Purchased Feed and Crop Costs per CWT. Page 28 of 43

29 Another reason for this difference may be revealed by the next ratio showing the Average Farms utilizing 3.26 Crop Acres per Cow, while the Study Group needs only 2.61 Crop Acres per Cow. Crop Acres per Cow is a measure of the efficiency with which the farmer utilizes crop land. Crop Acres per Cow Study Group Average Farms Difference (0.62) (0.50) (0.75) (0.73) (0.65) This could indicate that fewer Acres per Cow translates into more profit. Might this have something to do with time spent in the dairy facilities being more profitable than time spent in the field? Or might it indicate that because the Study Group had less land available they were forced to make the land more productive? Or does it indicate that what was produced on the land was of better quality, because crops were more easily planted and harvested in a timely manner? Or is it a combination of these and other factors? While our data allow only for speculation in this area, interesting questions arise from the data we do have. We acknowledge that since the Average Farms have more Acres per Cow, this would increase their Purchased Feed & Crop Cost per CWT. If percentage calculations were applied, 20% of the difference could be attributed to the extra acreage (3.26 less 2.61 is.65 divided by 3.26 equals 20% attributable to extra acreage). To be fair, we should reduce the $3.36 difference by 20%, which would leave $2.69/cwt. This narrows the gap, but the fact remains that the Study Group converts feed into milk more efficiently. The Study Group is getting 1,673 lbs more milk per cow with $2.69 less feed costs per CWT. This is a significant reason the Study Group is more profitable. All this points to significantly higher feed efficiencies for the Study Group. Another indicator of the feed efficiency is Milk Income over Total Feed Costs per Cow. Total feed costs include all purchased feed as well as home-grown feed fed. Home-grown feed includes the crops produced, adjusted for changes in inventory and sales. The table below shows those results. Page 29 of 43

30 Milk Income over Total Feed Costs/Cow Study Group $1,024 $2,280 $2,394 $1,492 $1,798 Average Farms $632 $1,808 $1,951 $1,098 $1,372 Difference $392 $472 $443 $394 $425 The Study Group yielded an average $425 more milk income over total feed costs. This seems to compare favorably with the discussion above. The quality of home-raised feeds harvested greatly impacts the cow s ability to produce milk. Quality of home-raised feed is affected by weather, selection of appropriate seed varieties, timely planting and harvesting, chemical and fertilizer application, proper feed storage, and more. Financial records only record the results of these management decisions and not the cause. To determine the cause of this difference would require study that is not possible based on financial records alone. The Study Group demonstrates a significant advantage in their ability to produce milk with greater feed efficiencies. This is one of the major differences in these groups of farms. The Study Group not only had better Production per Cow, they also had better Total Crop Production. Our best measure of crop production is the Dollar Value of the Crops Harvested per Acre. We use Standard Values for all crops, which have not changed for the years covered by this study. Thus, any increase in the Value of Crops Harvested per Acre is a result of increased Production per Acre. Crop production measured by the Value of Forage Harvested per Acre was: Value of Forage Harvested per Acre Study Group $583 $493 $487 $441 $501 Average Farms $433 $431 $388 $364 $404 Difference $150 $62 $99 $77 $97 Page 30 of 43

31 Crop production measured by the Value of Grains Harvested per Acre was: Value of Grains Harvested per Acre Study Group $369 $323 $323 $232 $312 Average Farms $287 $275 $233 $179 $244 Difference $82 $61 $79 $39 $68 For both the Value of Forage Harvested per Acre and the value of Grains Harvested per Acre, the Study Group consistently outperformed the Average Farms. The $97 and $68 advantages are significant and do positively influence profits for the Study Group. But at what cost was this advantage achieved? To study the cost of raising these crops, we looked first at the Direct Costs per Acre. Direct Costs include Seed, Chemicals and Fertilizer. The table below shows these costs for each group. Direct Costs per Acre Study Group $112 $123 $99 $88 $106 Average Farms $96 $112 $95 $75 $95 Difference $16 $11 $4 $13 $11 The Study Group produced more forages (24% more) and more grain (28% more) per acre than the Average Farms. They produce this additional feed with virtually the same Costs (12% more) per Acre. Looking at it on a per acre basis, the Study Group produced $97 more Forage per Acre and $68 more Grains per Acre, for an investment in Direct Costs of only $11 per Acre. Page 31 of 43

32 But it takes more than the listed Direct Costs to produce crops; what about Machinery Costs? Total Machinery Costs per Acre includes machinery repairs, fuel, vehicle expense, machinery depreciation, machine hire expense less custom work income, less Gas Tax Refunds, all divided by total crop acres. The results are listed below. Total Machinery Cost per Acre Study Group $206 $249 $236 $205 $224 Average Farms $220 $275 $235 $203 $233 Difference $(14) $(26) $1 $2 $(9) The Study Group spent $11.00 more for Direct Costs per Acre and $9.00 less Total Machinery Costs per Acre than the Average Farms. The difference of $2.00 per acre in overall costs is insignificant. Observation - the Study Group farms spend more money on the inputs that directly affect crop production levels, while the Average Farms spend more money on the things that do not increase production levels. Yields are influenced by things other than spending on fertility. They are influenced by precipitation, soil type and more. We do not have the data needed to prove any answers but we believe that the Average Farms could increase crop production by simply spending more on their ground and eliminating less productive ground. Part 3.9: Cows and Profits The number of cows, milked on a farm, has much to say about the potential profitability of that farm. As is evident from this table, the Study Group milks more cows. Here are our findings. Page 32 of 43

33 Number of Cows Milked Study Group Average Farms Difference The difference in cow numbers on the Study Group farms seems to be growing. The Study Group grew an average of 3.2% per year while the average group grew 2.0% per year. The gap between these farms is widening. The Average Farms spent on average $7, per year for dairy animals. This represents almost 4 cows per year. If they are buying 4 animals per year, they should have 130 cows in But instead they had only 121. The Average Farms were spending money to replace animals that did not make it to the milking string. The Study Group spent an average of $2,570 per year on dairy cows. This represents 1.25 cows per year. Over the 4 years this should have increased cow numbers to 161. But the Study Group grew to 171. This means that the Study Group met all culling needs and grew by a net of 10 cows as a result of Internal Herd Growth. Looking only at mature cows, the Study Group had an increase in Net Income and Assets (either Cash or Cows) of $25, over the 4-year period. Average Farms spending on Dairy Cows $7,943 Study Group Spending on Cows $2,570 $ 5,373 Study Group IHG $2,000) $20,000 Overall Study Group Advantage $25,373 An area where the Study Group farms stand out is in the area of Internal Herd Growth. As was just outlined, the Study Group farms derived nearly $6,500 per year of extra Net Income from their Internal Herd Growth (IHG) Practices. Internal Herd Growth calculates the rate of success the farm has had in producing more cows from heifers than were needed to meet culling and death loss. Page 33 of 43

34 It is an excellent measure of overall animal husbandry practices on the farm. The higher the IHG percentage is over 0%, the better. Here are the findings on IHG. Internal Herd Growth (IHG) Study Group 6.20% 2.00% 5.57% 5.20% 4.74% Average Farms (0.45)% (0.77)% 0.31% (0.36)% (0.32)% Difference 6.65% 2.77% 5.26% 5.56% 5.06% Observations - If the Average Farms had the same IHG as the Study Group, they would have increased their herd size by 24 cows (or had 24 more cows to sell) in the 4 years. Instead, they increased herd size by 7 cows and had to purchase 16 cows. They actually purchased cows to make up for the animals that did not make it into the herd. The Study Group farms were able to add 15 cows while purchasing only 5 cows. The Study Group had excess animals to sell to the Average Farms, who did not raise enough of their own. The Average Farms did have a positive IHG in But in all other years the IHG was negative. At the same time, the Study Group farms had positive IHG in all years. Reasons for this difference will require investigation that is not possible from the data available, but it appears that in times of poor milk prices, replacements suffer on the Average farms. This is something that does not happen on the Study Group farms. Many times Cull Rate is considered to be the biggest influence on the herd growth. While it is certainly important when calculating IHG, our findings refute that assumption. The Study Group had virtually the same cull rate as the Average Farms. Cull Rate Study Group 28.42% 30.42% 26.49% 29.50% 28.71% Average Farms 29.58% 28.98% 27.12% 28.91% 28.65% Difference (1.16)% 1.44% (0.63)% 0.59% 0.06% Page 34 of 43

35 Another indicator the industry has depended on is the number of Replacements per Cow maintained on the farm. Here are the findings (expressed as a percentage of heifers to the average number of cows). Replacements per Cow Study Group 89% 87% 86% 85% 87% Average Farms 84% 83% 81% 83% 83% Difference 5% 4% 5% 2% 4% The 4% advantage would provide the Study Group farms with an additional 3 heifers each year to bring into their herds. Nothing in our data indicates any increases in costs due to raising these extra replacements. Since the Cull Rates are nearly identical, the Study Group farms must be doing something better in order to have their herds growing internally. Our data do not offer detailed information on the more significant aspects of IHG such as Age of Heifers at First Calving, Calving Interval, Heifer Mortality, Calves Dead on Arrival and Heifers Culled in First Lactation. We believe that further investigation would show that the Study Farms excel in more than one of the above areas. Animal Husbandry Costs per CWT include vet, all supplies, breeding, production expenses, milk testing, bedding, hoof trimming and heifer raising costs, divided by milk produced. This is a good way to measure overall efficiency of animal husbandry practices on the farms. Animal Husbandry Costs per CWT Study Group $5.65 $5.96 $6.10 $4.79 $5.63 Average Farms $7.05 $6.77 $7.22 $5.64 $6.67 Difference $(1.40) $(0.81) $(1.12) $(0.85) $(1.04) Page 35 of 43

36 The Study Group farms have a decided advantage in these costs. We will look into Veterinary & Hoof Trimming Costs, Production Expense, Supplies and Milk Testing. Because changes in these expenses are not related to production changes, we will look at them on a per cow basis. Veterinary Expenses & Hoof Trimming per Cow is shown below. Veterinary Expenses & Hoof Trimming per Cow Study Group $89 $91 $84 $84 $87 Average Farms $109 $122 $116 $105 $113 Difference $(20) $(31) $(32) $(21) $(26) The Study Group farms have lower cost for Veterinary Expenses & Hoof Trimming per Cow. The gap widens in high income years. The overall impact of the $26 difference is insignificant. If the Average Farms had spent the same on Veterinary Expenses & Hoof Trimming as the Study Group, they would have increased their Net Margin (profit) by $3,146. Supplies Expenses per Cow includes bedding, milk house supplies and is shown below. Supplies Expenses per Cow Study Group $149 $166 $171 $131 $154 Average Farms $176 $200 $183 $171 $182 Difference $(27) $(34) $(12) $(40) $(28) Again, the Study Group farms had lower costs but the difference is small and insignificant. Page 36 of 43

37 Production Expenses per Cow includes any costs, not associated with feed, that enhance milk production. The most common of these expenses is rbst. The results are shown below. Production Expenses per Cow Study Group $13 $13 $19 $19 $16 Average Farms $19 $23 $25 $23 $23 Difference $(6) $(10) $(6) $(5) $(7) Observation - First, the Study Group farms produce more milk than the Average Farms but use less rbst and other production enhancers. Secondly, in the past 4 years the farms that make a profit are using less rbst. Granted the Average Farms used less in 2008 and 2009, but not to the degree of the Study Group farms. Experience has shown us that rbst can be a crutch for some farms. Given the amount spent per cow and the small difference, this is not a material Profit driver. Breeding Expenses per Cow is listed below. Breeding Expenses per Cow Study Group $51 $49 $55 $53 $52 Average Farms $43 $50 $48 $43 $46 Difference $8 $(1) $7 $10 $6 The Study Group farms spent their money on the things that have long-term impact on the farm. They spent more on the Direct Crop Inputs which leads to better fertility and yields. Here they spent more on breeding which should lead to better quality milk cows in the future, so long as the higher cost is not the result of rebreeding due to breeding failures. Data necessary to determine breeding frequency are not part Page 37 of 43