Maintain Margin of Profit as Well as Total Profit
Glenn A. Shirk, Extension Dairy Agent, Lancaster, Pa.
November 9, 2001
Large farm profits feel good when they exist, but don't overlook the importance of preserving good margins of profit per cwt. of milk also, because good margins can help you survive periods of depressed milk prices, as illustrated below. Both are important.
Let's look at two different farm situations, and let's keep the figures simple for easy calculation. One farm ships 12,000 cwt. of milk per year with 60 cows that average 20,000 lb. of milk. The other ships 24,000 cwt. with 120 cows producing 20,000 lb. each. Both farms currently show an annual profit of $36,000. That provides the smaller farm a profit margin of $3.00 per cwt., and the larger farm a margin of only $1.50 (This does not imply that larger farms operate with smaller margins of profit; often, they don't). Suddenly, the price of milk drops $1.00 per cwt. That's a hit of $12,000 for the smaller farm, and a $24,000 hit for the larger farm.
Instead of $36,000 profit, the smaller farm now has $24,000, whereas the larger farm has a mere $12,000! Ouch! The flip side to this is when milk prices rise, the larger farm outpaces the smaller farm. This enables a well-disciplined operator to lay aside some extra funds to fall back on when things do get tight. So, how can you manage for total profit and for profit margin?
Before long, producers will be summarizing their farm records to project their farm profits for the year and to begin implementing tax management strategies. The favorable milk prices of recent months may have sparked their enthusiasm for new purchases and/or for expansion of the farm business. If these decisions require additional financing and additional debt payments, this could add more strain to the business when milk prices fall or when costs escalate. These year-end purchases and investments may help reduce next year's tax payment, but will they generate enough additional profit that will make debt payments easier in the good times as well as in the bad times?
Consider getting better before getting bigger. Generally it is less risky and it helps contribute to a larger margin of profit per cwt. of milk. This might involve investing in technology and things that boost cows' health and comfort, hopefully enabling them to be more productive and more profitable.
If you are thinking of expansion, consider what size business you are capable of managing. As you get larger you start managing more people, and you manage them differently than cows. Will the expansion generate more profit and maintain reasonable profit margins? Will debt payments be affordable in the good times as well as in the bad times? If you can expand without a lot of extra capital cost, you can spread your present overhead cost over more units of production, thereby increasing profit margins per cwt. of milk. This might entail increasing cow and heifer numbers before a new facility is built, even if you have to "farm some cattle out" for someone else to raise temporarily. Or, temporarily overcrowd your present facilities and put up with all the inconveniences of doing so--but don't ask me to help! The payoff is you start growing your income base (cows and heifers) and cash reserves, while reducing present debt before incurring the cost of major expansion or renovation.
Situations will vary a lot from farm to farm, so push the pencil and work closely with your accountant and tax advisor. Consider profit margins as well as size and total profit. Try not to let profit margins shrink to the point where you become extremely vulnerable to even the slightest changes in costs or returns. Don't let gross income shrink to the point where you don't have enough dollars to pay the bills. That could force you to live off your depreciation, as your facilities and machinery deteriorate to the point where it becomes very costly to upgrade them. That could be the kiss of death for your business.
