Focus on Expansion

 

Milk quota abolition is now only nine months away. New entrants or expansion of an existing dairy farm are faced with significant challenges.  Over the last 12-24 months, Teagasc and others have held various ‘Dairy Expansion’ events.  What have been the key messages from these events?

Why?
Why do you want to expand? Many don’t have a real answer to this, it may be because ‘the neighbours are doing it’ or ‘we are expected to do it’. Others are motivated by ‘making more money’ but if you fall in this category you need to ensure the extra money you make doesn’t simply go on more inputs/a new employee or that you don’t sacrifices the lifestyle you want to achieve it.

Key point: Make sure you are expanding for the right reasons, not just because everyone else is doing it. Expansion can only be justified if it leads to increased farm profits consistent with an acceptable lifestyle.

 

Skills
If you are happy with why you are expanding, do you possess the skills required to make it successful?

As a dairy farmer you have a significant skill set but these will be tested in a larger enterprise. Some of the fundamental skills for expansion are:
1. Technical efficiency-a dairy farmer with an ‘average’ technical efficiency is likely to really struggle with larger output as more cows or higher output per cow will require a higher level of management.
2. Ability to think and plan strategically and financially-Significant expansion will almost certainly require capital investment; you need to assess what is the best investment for your farm. In addition, you will need to budget and manage cash flows (in the past businesses have had a profitable plan but have gone bust due to a lack of cashflow) and identify and manage key risks e.g. a major fall in milk price.

Possible expansion costs per extra cow*

 *from Teagasc Dairy Expansion Workshops

Measurement and Benchmarking
So are you a technically efficient dairy farmer?
How do you know?

Unless you are measuring your performance, you cannot know how well you are performing or compare yourself to others. Discussion groups are a good starting point, particularly where there is a high level of trust and honesty in the group.

Sometimes it is difficult to be certain about which measures are the most important or to benchmark against others as they may have different systems etc. For this reason, Teagasc have devised Key Performance Indicators (KPIs) for resilient dairy systems: The Dairy Scorecard.  The KPIs are relevant for all dairy systems and achievement of the KPIs will result in a sustainable milk production system. The KPIs are:

 

The system is designed to require minimal input of figures with most figures automatically inputted (with your permission from Dairygold, ICBF, etc.) and calculated.

This will give you significant insights into your farm’s physical performance and some insights into its financial performance. However, to make strategic financial decisions more detailed financial information is required. Your farm accounts are a good start; how much attention do you pay to them or are they simply completed because you have to? The Teagasc profit monitor is an excellent bridge between physical and financial performance. Yes, it takes some time to complete and you may need some guidance on how to do it but it is time well spent and can give you key insights into your farm’s current performance and future target areas.

 Key point: Know your own farms Key performance indicators, setup means of measuring them and benchmark this performance against others.

Profit versus Cash Flow
Your farm is a business and is run to make a profit. Profit is your reward for the time, effort and money you have invested in your business. Typically, larger profits mean the farm has performed well. Below is a simple example of how profit is calculated:

Sales    € 100,000
 + Increase in livestock inventory  €   10,000
     € 110,000
Minus    
Cash Costs  € 65,000  
Interest  €   5,000  
Depreciation  €   5,000  
     €   75,000
 = Profit    €   35,000

Key point: Profit is your reward for the time, effort and money you have invested in your business. Typically, larger profits mean good farm performance.

Where does your profit go?
You can’t put profit into your back pocket but you do decide where it goes. Typically profit is channeled in different directions including:
1. Paying tax
Tax is an unfortunate side effect of making profit. You have to pay it. It is worth considering setting aside (standing order to a separate bank account) a certain amount of money every month to cover your annual bill.
2. Repaying farm debt
A loan repayment consists of interest which is a deductible tax expense (already paid before profit is calculated) and the principle or amount borrowed which is not tax deductible. Loan repayments again have to be paid but it could be decided to make additional payments against the loan.
3. Drawings/Living expenses
This is the cash you need to support yourself, your family, your lifestyle and saving for your retirement. This should be a priority and it is good practice to have a monthly standing order from your farm business account to a personal one.
4. Business investment
New (not replacing an asset already on your farm-already included in the calculation of profit through the depreciation charge) investment in your farm. New buildings or machinery or purchasing land are examples. Alternatively it could be cash left in the farm business account to be invested in the coming year in land drainage etc.

Profit allocation from the previous example was as follows:

 = Profit    € 35,000
Allocated To    
Tax Paid  € 5,000  
Debt Principal Paid  € 2,000  
Reinvestment  € 8,000  
Drawings  € 2,000  
     € 35,000
 = Cashflow    €        -  

 
This explains where the year’s profit went to and why profit is not cash. There is only so much profit available and you have to decide how best to allocate it. Paying tax and making loan repayments are pretty much set in stone while the remaining cash is the discretionary or free cash.

Key point: Profit is not cash but you need to decide how best to distribute it

Calculating Discretionary or Free Cash
This is the real cash figure that you can decide how to spend. Using the example above non-cash items in the profit calculation are excluded (livestock inventory increase and depreciation).

 

Sales      € 100,000
       
Minus      
Cash Costs  € 65,000    
Interest  €   5,000    
     €   70,000  
Allocated To      
Tax Paid  €   5,000    
Debt Principal Paid  €   2,000    
     €     7,000  
       €   77,000
       
 = Discretionary or Free Cash  €   23,000

 

New investment is excluded and drawings as these are within your control; although it is important to be aware of what is a minimum level of drawings you require. Options for discretionary cash are:
• Drawings
• Investment in the farm business
• Accelerated debt repayments

Calculation of this figure allows you to make an informed decision on how much to use for each of the three options. To do this is necessary to make a forward cash flow budget and monitor the actual cash flow versus the budget.

Key point: Calculation of Discretionary or Free Cash gives you confidence and control to manage your business and make an informed decision on how to best use it

What are the banks looking for?
 
Most dairy farmers targeting significant expansion will have to borrow money to do so. There are a number of crucial points to be aware of before you make a formal approach to a bank:
• Farm financial accounts are the base for any proposal to borrow to money from a bank to grow your business
• Milk statements, Profit monitor and Herd Plus give the bank insights into your technical efficiency
• Discretionary (cash available to service any new loan) is crucial
• Banks will ‘stress test’ your repayment capacity on milk price falling to €0.30/litre and interest rates increasing
• Banks assume some temporary loss in technical efficiency in large scale expansion
• Detailed tax planning is required
• Ensure you have significant contingency (15-20%) for farm buildings and land improvements
• Have a plan B and consider other options

Key point: Be prepared before you approach a bank for a loan, they will want to see your accounts etc. and will perform stress tests on your ability to service the loan

Risk Management
Significant expansion has significant risks. It is important to put some time into thinking about what the key risks to the expansion of your dairy business, and most importantly, what you can do to limit the likelihood and impact of it occurring. Some risks will be common to all dairy farms; others may be unique to yours. The table below suggests some useful headings and a couple of examples.

       

Key point: Expansion has risks. Identify the risks to your expansion plans and what you can do to reduce them

Get in touch 

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