Decisions! Financing Dairy Investments: Upgrades and Expansion

Farm Business Management Update, June 2000

By Jack Dunford and Bill Whittle

Financing Dairy Investments

Every investment has a driving force behind it: to make money, to meet regulations, to make life better. You need to give thought to the force influencing your desire to make a substantial investment in your farm. This potential investment should provide one or more of the following for your farm:

• Increased income;
• Long-term viability of the farm;
• Improved safety for employees and/or cows;
• Improved comfort for employees and/or cows;
• Adherence to current and foreseeable future regulations.

The process you use when deciding to upgrade or expand the dairy includes the basic business decisions necessary to successfully operate a farm. The key question "Why are you making this investment?" should be addressed well before the expenditure of money. To answer this question you first need to answer several other questions that get to the root of your farming enterprise.

• Why are you in the business of milking cows?
• Does your farm currently provide the financial livelihood and quality of life you desire?
• What are your goals for the farm? If you are near retirement, do you have someone to take over the farm? How do environmental regulations, future development, etc. fit into this decision?
• Do you really like to milk cows?
• What is your labor situation?
• With an expansion, will you be managing cows or people? Can you manage people?
• Can you find healthy cows that will fit your herd?
• Does sound business reasoning to support your decision?

Once you have answered these questions (and possibly more) to your satisfaction and probably your lenders' satisfaction, you need to examine the financial outlook for the expansion/upgrade. Several methods are available to you as you evaluate your farming operation. Cash flow projections are a primary tool for evaluating your financial status and ability to meet your obligations. Cash flow projections can be made using enterprise records for specific periods: Monthly, Quarterly, Yearly. Your Schedule F can be used as a quick, yearly cash flow. Available tools also include enterprise budgets for your dairy to determine your current and expected post-expansion financial situation and partial budgets specifically to evaluate only the expansion/upgrade. The Schedule F can also provide a quick benchmark of "net income per cow" to compare with industry averages.

Budget 1: Dairy Cow Budget based on Corn Silage/Alfalfa Haylage allows you to look at all cash income and expenses specific to your farm. (This budget and several other templates for dairies are available from Virginia Cooperative Extension's Crop and Livestock Budgets in both printed form and on spreadsheets.) The "bottom line" on the enterprise budget, "Return to Equity, Management, and Operating Labor" will help determine if there is enough money available to finance the expansion/upgrade.

Budgets 2: The Partial Budget allows you to look only at the change being considered. It gives you a process to work through how both financial and management will affect the dairy business. As you consider a partial budget, you would evaluate every item associated with the change that might affect the farm and then quantify the effect by assigning dollar amounts to each. The evaluation includes listing specific items that add to receipts and every item that reduces cost. These categories add positive value to the change being considered. On the other side, you must evaluate specific items that reduce receipts and add to the cost. To provide a clear picture of the change, these two categories need to be considered carefully to insure that no hidden costs will create problems down the road. The last line in the Partial Budget, "Net Difference Due To Change," provides a dollar value that tells you if the change is worth making. A positive dollar amount means that after the change is made, you will have more dollars than before the change. However, if the amount is small it may not be worth taking the risk to initiate the change. If the Net Difference Due to Change is negative, you would need to re-evaluate the necessity for the change.

The Partial Budget is probably not an appropriate tool if your farm is already heavily in debt or the change itself will require a high level of financing. In situations where you would have more than 50 percent total farm debt (even less debt in certain situations), the partial budget could still be used as a screening tool to evaluate the change. Then follow it with an enterprise budget or cash flow to make a more accurate projection.

Another useful tool when evaluating your financial status and efficiency is to look at Net Income Per Cow. If your farm is primarily a dairy without other enterprises (or you have enterprise information available) the Schedule F provides a quick method of determining net income on a per cow basis. Divide the average number of cows for the past year into Schedule F, Line 36, Net Farm Profit (Loss). This process can be done with data from past years to give you a historical view of your farm as well as the current year. The value you get is one piece of the equation that helps you determine if you are financially efficient, compared to industry averages, at your current level of production. If not, you need to consider carefully if the change will increase or decrease your financial efficiency.

Some final points to consider include

• Start small. Few typical family-sized farms have the financial resources to enter into a large expansion.
• Profitability and cash flow are not the same. Financing arrangements and debt service often make a profitable investment infeasible.
• Maintaining herd productivity is important. Any improvement in productivity may not be achieved until after the expansion transition stage. Productivity of the current milking herd may decline as increased demands on managerial resources result in a decrease in the time available to work with the dairy herd. Purchased cows must also be managed carefully and will often perform at a lower level than the current herd, particularly with high producing herds.
• Structuring the farm plan to survive declines in output prices ensures survival of the farm after expansion. If prices are higher than what is budgeted, the farm is more profitable. If prices fall, the farm still has the ability to make debt payments.

Example Dairy Budget: Corn Silage / Alfalfa Haylage

Partial Budget Form

Contact the authors at dunford@vt.edu and wwhittle@vt.edu .

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