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

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

Context

Annual Class III Prices

Annual Class III

Monthly Class III Prices

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

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

CFFM Data (cost)

Net Farm Income From Operations (cost) CFFM: cow dairies, free stall, no organic, no rotational grazing CDP: cows, all else the same

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

ROROE (cost basis w tax depreciation) CDP: Cow Dairies in WI (freestall, no pasture, no organic)

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

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

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

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

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

2006 (CDP, cows) Mrkt Value of Assets and Economic Depreciation Performance MeasureLow 25%Middle 25%Top 25% Current Ratio Working Capital:Total Expenses13.3% Working Capital:Gross Revenue12.5% Debt:Asset44.2% Assets:Equity ROROE-5.1% ROROA-.55% OPM-1.48% ATO37.0% Interest$35,947$29,799$31,205 Interest:Assets Total Assets (Mrkt)$1,561,716$1,918,484$1,403,604 Number of Cows

2007 (CDP, cows) Mrkt Value of Assets and Economic Depreciation Performance MeasureLow 25%Middle 25%Top 25% Current Ratio Working Capital:Total Expenses Working Capital:Gross Revenue Debt:Asset Assets:Equity ROROE ROROA OPM ATO Interest44,66735,18229,334 Interest:Assets Total Assets (Mrkt, ending)1,979,9792,067,7141,517,532 Number of Cows

2008 (CDP, cows) Mrkt Value of Assets and Economic Depreciation Performance MeasureLow 28%Middle 28%Top 28% Current Ratio Working Capital:Total Expenses16.6% Working Capital:Gross Revenue15.8% Debt:Asset47.5% Assets:Equity ROROE-3.17% ROROA.92% OPM2.28% ATO40.4% Interest$44,062$29,836$34,540 Interest:Assets2.55% Total Assets (Mrkt)$1,726,032$2,202,736$1,888,622 Number of Cows

2008 (CDP, cows) Mrkt Value of Assets and Economic Depreciation Performance MeasureLowMiddleTop Basic Cost:GR Wages Paid:GR Interest:GR Depreciation:GR NFIFO:GR Milk sold per cow18,98021,09021,912 SCC234,611208,500213,917 Crop Acres per cow Forage Acres per cow Debt per cow5,0482,9423,438 Net Milk Price Cows Total Assets (Mrkt ending)1,824,6002,202,7361,888,622

Our Economic World Today Interdependent –As trading nations VOLATILITY Dairy Industry structure Energy Technology Interdependent –As businesses

I’m Procrastinating What’s your mission –Profits for bank –Satisfied and profitable customer –Reasonable risk-return Farm Customer Choices 1.Path back to profitability (SR & LR) Underlying structure (finance) - Dupont Mgt capacity (adaptability, business sense) Personal condition (age, family help, equity, off- farm income) 2.Financially “happy” exit (Phil)

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

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

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

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. Is there current cash flow? (through harvest, through Spring planting)

NO: –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 Generate Cash Flow

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

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 Is There Sustainable Profitability?

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

Introducing the DuPont System for Financial Analysis

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)

DuPont System – What is It? The system identifies profitability as being impacted by three different levers: 1.Earnings & efficiency in earnings 2.Ability of your assets to be turned into profits 3.Financial leverage Earnings Turnings Leverage

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

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

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

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

Accept & Finance Plan? NOYES PlanDoCheckAct Re-Engineer Operation Liquidation Situation

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

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

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

Banker on Management Team?

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