The unthinkable events that occurred in the first six months of 2020 will more than likely have an exceptionally long tail. That tail could be 12 to 24 months out or it may even be years long. It is important to make short-term adjustments on the dairy farm to try to cope with recent events.
Six months and 12 months can now be defined as short-term planning, considering the far-reaching human health and worldwide economic impact of 2020. Historically, huge upsets have taken years, and in some cases decades, for people to adjust and deal with their future world. Currently, dairy producers need to look beyond 2020 into the next three years to start making longer-term decisions.
So far, 2020 has dealt farmers a dose of hyper volatility. Milk prices have been on a trampoline with an array of government payments trying to fill farm income gaps. A recognition that food on the grocery shelves really comes from the farm has now been renewed in many urban consumers. Miles of cars in large cities waiting for nonprofit or government food boxes has driven dairy prices at present. Now, what should dairy producers and other farmers do to plan best for the distant future financially?
Re-evaluating the farm
It will be anyone’s guess of what will come. Long-term thinking should take everyone back to what might be considered by some as basic or, as some might even say, “old school” thinking when it comes to firm financials.
1. A strong balance sheet is always the place to start. Less than a 40% equity leverage may show a nice return on equity; however, a 50%-plus equity leverage allows the farmer a needed borrowing ability when blindsided by economic surprises that are beyond their control.
2. Working capital . . . better stated as the current assets to current liabilities . . . will need to be maintained at a strong ratio. A 2:1 ratio would be best, with a 1.5:1 ratio necessary.
3. Debt to revenue of 1:1 will be safe with 2:1 pushing the envelope.
a. Interest rates are as low as they can go at present with negative rates unlikely.
b. Now is a time to refinance and lock in rates for the long term if possible. Be aware of prepayment penalties and the additional fine print of loan documents. Make sure discussions with lenders clarify long reaching commitments.
c. Refinancing real estate long term with lower payments can improve cash flow immensely. A 20-year loan can always be paid back sooner if extra cash allows. In lean years, the lower payments make financial breathing easier.
4. Lines of credit (LOC) should be secured for annual operating and other needs should they occur. A $500 to $1,000 LOC per cow would give a cushion if and when needed.
5. Do not fear building cash in the farm checking or a money market account, even if the paid interest rate is low. At times, $100 to $500 per cow may seem like a lot of money. However, when sound opportunities knock, deals can be made. Cash on hand allows for quick action.
6. Cash flow projections are a must as part of a business plan. They need to be monitored monthly and quarterly and evaluated annually.
7. Accrual income statements need to be completed as close to year-end as possible with accurate balance sheets to verify inventory changes.
8. Cost of production (COP) for the present year must be watched quarterly and annually. Adjustments have to be considered to squeeze a few cents out of every dollar spent.
9. Taking positions on milk marketing through government programs and brokers should be evaluated when the true COPs are known. When making a final decision, it’s ultimately the farm owner’s call.
10. Annual business plans need to be discussed with family, key employees, other workers for ideas, and with advisers. The plan should include a one to three-page summary followed with 10 to 50 pages of what the next year’s plan will be.
11. Expansion plans and operation changes will be considered by many farmers. Historical progress is important along with many details for future changes.
12. Farm transition planning is important so future family owners and nonfamily can receive proper training. This process should have a 10-year planning window.
Keep your cool
Building financial strength in the farm’s balance sheet and income statements for future operation and shocks is important. It may take years for the present fog to lift and a clearer picture to appear. Limit the current emotion with a balanced business head short term. Start thinking beyond 2020 to be watchful and planning for 12 to 24 months out for a longer-term solution.