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Business Management Strategies for High Milk Prices

Posted: July 9, 2004

Dairy producers experienced record high milk prices during the past couple of months. These prices were a welcome relief after an extended period of below average prices. Although prices during the next 3-6 months are not going to be close to the high received in May and June, futures prices do indicate an opportunity to receive milk prices that are well above the average long-term price. What should dairy producers be doing during this upward swing in milk prices to position their businesses to deal with the next downturn in the price cycle? First and foremost, realize that the record high prices were only temporary. Therefore, it is important to make the most of this golden (figuratively and literally speaking) opportunity. Here are some tips for dealing with high milk prices.

Look for the marginal milk on your farm. Although it may cost you $14.00 to produce 100 pounds of milk (or 14 cents per pound), producing additional milk will cost approximately three to four cents per pound. Current milk production already covers fixed costs so the only costs one should incur for the increased production are additional feed costs. The cost of feed is approximately eight to nine cents per pound of dry matter, even at current commodity prices. Each pound of dry matter should yield an additional 2.5 to 3.0 pounds of milk. Thus you can see where marginal milk will cost you three to four cents per pound. You can often produce that marginal milk through simple changes in your management practices. Focus on changes which yield quick results. Examine cow grouping strategies to ensure dry matter intake is not inhibited in first lactation animals and that cows are not dropping off in production significantly when moved between groups. Feed or push up feed more often. Evaluate your ration and feeding strategies. Feed some by-pass protein sources (ensure adequate lysine and methionine levels are fed) and possibly a high energy fat source. Focus on producing and feeding the best quality forage possible.

Consider milking three times per day during the high price cycle. Your herd will see production increases in the range of seven to eight pounds of milk per cow per day. The increase will occur almost instantly. If this practice puts a strain on the labor force, return to 2X milking when prices start to fall. Let your employees know this is a temporary situation and consider paying them an increased wage rate for the extra milking. With the price of milk over $16.00 per cwt. and in some months approaching or exceeding $20.00, it doesn’t take long to pay for the extra feed and labor required to implement this management practice.

Manage Components
Component levels can have a big impact on milk price. Low fat and/or protein tests can reduce milk prices by $2.00 per cwt or more. Balance the ration to ensure components are at acceptable levels (3.7-3.8 percent fat and 3.0 percent protein for Holsteins). If low fat tests are a problem, check forage quality, fiber levels, fermentation profiles and particle size. Also check water quality and check forages for the presence of molds or toxins. If fat test are higher than 3.7-3.8 percent in Holsteins, there is a good chance the herd could be producing more milk. Analyze the situation to determine whether the higher price received as a result of the higher components is more than covering the lost milk. Adjust the ration if necessary.

Keep facilities full; over-crowd if possible.
Don’t lose added profits these high milk prices can generate. If you have an empty stall in your barn, fill it. Remember, a large portion of the expenses to produce milk are fixed. By keeping the barn full you will spread those fixed costs over more units and thus reduce your total cost of production. If you can overcrowd your barn without losing production, do so. Most freestall barns can be overcrowded 10-15 percent without losing production, but each operation is unique. Monitor the impact of overcrowding on production to ensure you have not reached the point of diminishing returns (losing production).

Produce and Feed High Quality Forages.
This has been extremely difficult this spring. However, many producers were lucky enough to get first cutting hay completed before the pattern of frequent rain set in. If you were not one of the lucky ones, make an attempt to isolate low quality forage from the better material. Feed the higher quality forage to transition and high producing cows. If you do not have high quality forages, consider purchasing some. Again, with high prices, it doesn’t take much to pay for the added cost.

Apply Cash Reserves Wisely.
The high prices will generate some phenomenal cash surpluses on most dairies. Be sure to use these surpluses wisely. Don’t rush out and purchase nonproducing assets. Remember, these prices can disappear as quickly as they came. Use these cash surpluses to position your operation to survive the next down turn in the price cycle. Here is a list of priorities for using the cash surpluses you will see.

Pay down debt.
Many operations have accumulated a substantial amount of operating debt during the past 18-24 months. Repaying this debt should be a primary goal of the business owners. Use the cash surpluses generated during the period of high milk prices to pay down debt in the following order:

  • Focus on paying off open accounts. Vendors are not in the finance business and therefore charge extremely high interest rates on their accounts receivable. Interest charges on open accounts are a non-productive expense that increases the overhead costs of producing milk. Accounts payable should be the first target for cash surpluses. By reducing these liabilities, you will incur less interest expense and will position your operation to receive the cash discounts many vendors offer, thus reducing production costs even further.
  • Next, pay down operating lines of credit. Many operating lines have been maxed out over the past 18- 24 months, and some have even been restructured and amortized over time to help improve cash flow.

    After paying off open accounts, focus on reducing revolving lines of credit. Paying down these notes will free up funds for future needs when prices fall again. After paying down your lines of credit, focus on paying off any revolving notes that were restructured during the down price cycle. These notes represent unproductive debt that creates a cash flow drain on your operation. Refinancing these notes was a good idea that ultimately helped cash flow and improved the lender’s loan portfolio in the down price cycle. However, such notes now consume funds that the operation could be using for investing in productive assets. Paying these notes down will improve the financial position of the business and provide opportunity in the future to make needed improvements.

After paying down debt there are several options for using the cash reserves.
The order in which they should be prioritized will vary by operation, but focusing funds toward one or two of these options should help improve the financial position of the business.

Pay off short-term debt.
The next target for cash surpluses should be short-term notes. Equipment and cows notes are often amortized over three to five years. Paying off these notes can significantly improve the future cash flow position of the business.

Build a rainy day fund.
Set money aside for future emergencies, to pay income taxes or to use during the next down cycle in milk prices. Find an investment tool that provides reasonable yields but is also liquid (easily converted to cash).

Pay estimated income taxes.
A good tax accountant can certainly help control income taxes, but in a year such as producers are currently experiencing, paying some taxes are
inevitable. Farmers can avoid paying any estimated taxes
without incurring any penalties as long as tax returns are filed
by March 1st of the following year. A better decision than
paying estimated taxes would be to build the rainy day fund,
and receive interest on that money. However, some people
prefer the peace of mind knowing their tax obligations are
taken care of, so paying estimated taxes is an option.

Invest in productive assets or replace assets as needed.
In some instances this may be a preferred use of the cash
surpluses an operation will see. If an investment will
significantly improve profitability and cash flow, spending
money on it is a good business decision. In other situations,
replacing an essential asset, such as a mixer wagon, may be
necessary. Rather than paying down a short term note and
financing the purchase, use the cash reserves to buy the asset
outright. However, be sure to check out interest rates. It
would be a wise decision to pay off a loan with a higher
interest rate than the new asset could be financed for.

Decision-making changes as milk prices fluctuate. Although
the basic principals remain the same, the strategies and tactics
for dealing with different price environments will shift.
Examine your strategies and tactics to ensure that you are
making the best possible decisions concerning the use of the
cash surpluses your business will generate in the next several months. Doing so can mean the difference between surviving
or not surviving the next downturn in milk prices.

Brad J. Hilty, Information Management Specialist, Penn State Dairy Alliance