Working with Dairy Businesses in Challenging Times

1. Working with Dairy Businesses in Challenging Times Kimberly, WI September 11, 2009 Kevin Bernhardt UW-Platteville/Extension

2. John and Mary Dairy Case Study

3. Participant Case Study Comments: • What is the son thinking! • What is the daughter-in-law’s education • Operation performance, yield, production • Why does the profitability look the way it does? • Family living expense / lifestyle • Condition of facilities • How much does the son want • Relationship with suppliers • Capital assets • Why is milk production dropping

4. Context

9. Annual Class III Prices

10. Annual Class III

11. Monthly Class III Prices 14 18 23 19-24

12. Per cwt costs, prices, & income after charge for Labor/Mgt CFFM: 101-200 cow dairies, Free stall, no organic or pasture

13. CDP: 100-250 Cow Dairies in WI (freestall, no pasture, not organic, cost basis of assets) 5 of last 6 years ROE>ROA

14. CFFM Data (cost)

15. Net Farm Income From Operations (cost)CFFM: 101-200 cow dairies, free stall, no organic, no rotational grazingCDP: 100-250 cows, all else the same

16. WE ARE NOT ALL THE SAME and NOBODY IS THE AVERAGE!

17. ROROE (cost basis w tax depreciation)CDP: 100-250 Cow Dairies in WI (freestall, no pasture, no organic)

18. ROROE (mrkt basis w economic depreciation)CDP: 100-250 Cow Dairies in WI (freestall, no pasture, not organic, cost basis of assets)

19. 2008 ROROE & ROROA (cost w tax depr.)CDP: 100-250 Cow Dairies in WI (freestall, no pasture, not organic, cost basis of assets)

20. 2006 ROROE & ROROA (cost w tax depr.)CDP: 100-250 Cow Dairies in WI (freestall, no pasture, not organic, cost basis of assets)

21. Net Farm Income (Mrkt w. Econ Depr)CDP (same farms): 100-250 cows, freestalls, no organic, no pasture

22. Net Farm Income From Operations (cost w. Tax Depr)CDP (same farms): 100-250 cows, freestalls, no organic, no pasture

23. 2006 (CDP, 100-250 cows)Mrkt Value of Assets and Economic Depreciation

24. 2007 (CDP, 100-250 cows)Mrkt Value of Assets and Economic Depreciation

25. 2008 (CDP, 100-250 cows)Mrkt Value of Assets and Economic Depreciation

26. 2008 (CDP, 100-250 cows)Mrkt Value of Assets and Economic Depreciation

27. Our Economic World Today • Interdependent • As trading nations • VOLATILITY • Dairy Industry structure • Energy • Technology • Interdependent • As businesses

28. I’m Procrastinating • What’s your mission • Profits for bank • Satisfied and profitable customer • Reasonable risk-return • Farm Customer Choices • Path back to profitability (SR & LR) • Underlying structure (finance) - Dupont • Mgt capacity (adaptability, business sense) • Personal condition (age, family help, equity, off-farm income) • Financially “happy” exit (Phil)

29. Path back to profitability may take some bridge building • Short Run • Debt restructuring • Increase working capital • Innovative payment arrangements • Long Run • Financial Analysis • Partial Budgeting • Operational/Strategic alignments • Strategic and Business Planning

30. Is there current cash flow? (through harvest, through Spring planting) NO YES Generate Cash Flow NO Liquidation Situation Is there sustainable profitability?

31. They Cash Flow, Now is there sustainable profitability? • Financial & Management Diagnostics • Efficiency -Efficiency • Scale -Turnings • Debt structure -Leverage • 5 C’s -Character Liquidation Situation YES NO NO GO Accept & Finance Plan? Re-Engineer Operation YES

32. Is there current cash flow? (through harvest, through Spring planting) • Are cash receipts expected to cover cash costs? • Is there some contribution to overhead? • Is current ratio 1.5 and working capital at least enough to cover family living and debt payments • WC:GR > 20-25% • Is Ending cash flow:All cash expenses >10% • If Yes: Move onto next question (profitability) • Cut cash costs where possible • Don’t throw the baby out with the bathwater.

33. NO: Generate Cash Flow • Cut cash costs where possible • Don’t throw the baby out with the bathwater • Outsource low return activities and sell assets • Interest only payments • Restructure and lengthen amortization • New or increased operating lines • Sale of non productive capital assets • Sale of inventory (sale and re-own) • Elimination/Sale of non profitable enterprises

34. NO: Generate Cash Flow • Investment partner • Delay new capital asset purchases • Lower family living • Off-farm employment

35. Is There Sustainable Profitability? • Is ROROE at a sufficient level to meet business and family objectives? • Is ROROE competitive with other opportunities? • Is ROROA > interest rate • And thus ROROE > ROROA • Is the value of unpaid labor and management covered? • Is depreciation covered? • Is a payment to equity capital covered

36. Financial & Management Diagnostics • Multiple years (trends) • Cost and market basis • Accrual • Benchmark • Search for Where should management time and creativity be targeted? And

37. Introducing the DuPont System for Financial Analysis DuPont

38. DuPont System • “DuPont Financial Analysis Model is a rather straightforward method for assessing the factors that influence a firm’s financial performance.” (Gunderson, Detre, and Boehlje, AgriMarketing 2005)

39. DuPont System – What is It? • The system identifies profitability as being impacted by three different levers: • Earnings & efficiency in earnings • Ability of your assets to be turned into profits • Financial leverage Earnings Turnings Leverage

40. DuPont System Earnings Operating Profit Margin Return On Assets (less interest adj.) IncomeStream = X Asset Turnover Return On Equity = X Turnings Financial Structure InvestmentStream Leverage

41. OK Total Revenue = cash income +(-) inventory changes Basic Costs = cash expenses +(-) accrual exp changes + purch lstk Depr Non Basic Costs = labor + depreciation + interest expenses Too Low NFIFO – unpaid labor/mgt + interestTotal Revenue OPMR Earnings Return On Assets Too Low = X Total RevenueTotal Assets Turnings OK ATO Return On Equity = X Too Low Total AssetsTotal Equity OK Leverage

42. OK NFIFO – unpaid labor/mgt + interestTotal Revenue OPMR Earnings Return On Assets Too Low = X Total RevenueTotal Assets Turnings Too Low ATO - Unproductive machinery? - Buildings not being used? - Breeding livestock not producing? - Unproductive land? Return On Equity = X Too Low Total AssetsTotal Equity OK Leverage

43. Is There Sustainable Profitability? NO: • Strategic Planning • Partial Budgeting • Plan the work - work the plan • Strategic alignments • Efficiency, Scale, Structure • Labor utilization Re-Engineer Operation YES GO

44. Accept & Finance Plan? NO YES Re-Engineer Operation Liquidation Situation

45. What Else? • Reduce Risk • Loan Guarantee Programs • Marketing • Production • Fixed interest rates (secondary market) • Insurance checkup • Labor • Health • Sensitivity Analysis

46. 5 C’s • Collateral • yes, but! • Conditions • What is the loan for? • Capacity • Capital • Character • Not a computational task!

47. Be Creative • Is it better to stick to your rules and policies, or find a way to get some money back? • Good managers in bad situations could be good future & profitable customers • How can you minimize losses

48. Banker on Management Team?

49. Finally There is a reason they put a human behind the lenders desk and it’s not for when times are good