By D. Clair Doan
Associate Vice President, Agriculture
Ontario for National Bank
Adaptability is one word that all people including farmers, have experienced in operating businesses in a fluid and changing environment, particularly these past two years. In the coming months, the skill of adapting will continue to be ever more important where elements of volatility will persist in operating profitable dairy farms under the reality of rising costs and limited resources.
A key benefit of supply management remain its access to domestic markets with prices established by the Canadian Dairy Commission. The recent announcement indicating a price adjustment of approximately $6.31/hl or 8.4% will help to offset increased input costs and following the pressure of increased input costs including all aspects of production from crop inputs to labour and interest rates.
The next few years in dairy production will be marked by domestic growth partially taken up by additional imports from Europe, members of the CPTPP as well as CUSMA. As the implementation of these agreements is completed, the Canadian dairy industry will reclaim the growth of the Canadian market, which is expected to be solid at 3% annually. The offsets for the first two agreements mentioned, with final payments scheduled for 2022 and 2023, help to mitigate their negative effects.
Even with the revenue adjustment, farmers can expect further volatility and their primary focus should remain on cost management. We cannot assume all price increases will be passed along to consumers in the future plus it remains an unknown impact on demand as consumers look to manage their household spending. At the same time, not only does the market continue to demand a product of impeccable quality at a competitive price; consumers are increasingly interested in how it is produced. Carbon footprint, water protection, healthy cohabitation, etc., the dairy community must maintain a high level of concern in these areas. Maintaining the excellent market position of Canadian dairy products is directly related to this.
Despite some headwinds, including high input prices, Canadian dairy farmers are optimistic about the future. This is evidenced by the steady increase in the value of milk quotas in the Prairie Provinces (while their value is capped in the Eastern Provinces, it recently reached $50K in Alberta). Unquestionably, a strong confidence in the future is expressed through this growth in value.
Now that the winter months are upon us, most feed as been put away for the year ahead, farmers across the country reflect on the variability in their growing conditions, perhaps more so in western versus central Canada, but no matter the location, all farmers have noticed increased costs in nearly every category of expenses. This is an ideal time of year to understand last years costs and start planning and budgeting for the year ahead.
Cost minimization in supply management sectors remains the key driver in on farm profitability. Given the rise of increased input costs over the past year, its never too late to generate your year-to-date comparable reports to understand where the costs are changing and by how much and start budgeting for 2022. These often include feed costs, including crop inputs, labour and custom work, health and reproduction, building and equipment repairs as well as interest costs as the largest expense categories. Thus, focus on your greatest expenditures and those that have varied over time to ensure you understand how these may continue to increase and putting these into a budget today.
Every farm has a unique mix of assets that include barn facilities, cattle, quota holdings, labour availability and land base, however many farmers have strived to maximize production output, which may be the right strategy for some farmers, but understanding the costs in relation to production output must be fully known. With the rapid increase of feed and input prices, what is your return over feed costs? It is not necessarily the feed cost per tonne but understanding the total output of production and how that relates to the overall farm system, capacity, and limitations. Farms with limitations on facilities will approach this differently than the farm with surplus capacity or cattle, however understanding your own individual farm as a system unique to each operator is key.
Benchmarking your farm in comparison to peers can be done with the support of key advisors such as farm management groups, accountants, bankers and alike. Understanding the unique aspects of every farm, reviewing the overall farm from a financial efficiency perspective with comparisons year over year help establish your on-farm trends. Considering total expenses as a percentage of total income will determine the efficiency ratio. However, from a banker’s perspective, we often look at the expenses with the interest and depreciation costs removed to compare the variable costs in establishing on farm profitability to compare management and farm profitability among peers. These ratios will vary across region where top managers may be below 50% with other areas in the low 60% of costs related to gross income. Through benchmarking, identifying peers who operate in the most efficient quartile, can often establish goals for on farm cost management.
Despite the results of on farm efficiency, it ultimately comes back to the on-farm profitability and how much money is available to cover living costs, debt carrying costs and funds available for growth and further on farm investment, relative to the farm itself. It is this final number that matters, with this value stress testing the cashflow of the farm operation. Testing needs to be done on several metrics, such as fluctuation to income, be it milk price or quota allotment; the variability of input cost changes or in broad terms, the efficiency ratio, testing of interest rate variability, which is relevant to on farm debt levels and considerations for asset acquisition. Stress testing your operation is about knowing your numbers and having the knowledge to implement strategies in being proactive versus reactive in volatile markets.
Farmers have benefited from the stability and predictability of the Canadian dairy system and will continue to do so for years to come, however the pace of increased costs is occurring at a quicker rate than in the past. Farmers will need to adapt and more importantly plan and budget for the year ahead, including stress testing your business, knowing the cashflow, establishing goals related to strengthening the business and being prepared for uncertainty that we perhaps have not faced in the past. If this seems daunting, do not hesitate to reach out to your trusted advisors where we all benefit from working with profitable farm businesses.
This article was written for the Winter 2021 Dairy Grist. To read the whole Dairy Grist, click the button below.