DAIRY BUSINESS MANAGEMENT
R J Gordijn and E N C Whitehead
Directorate of Agricultural Economics,
Cedara Agricultural Development Institute
INTRODUCTION
In this leaflet it is assumed that the farmer's goal is to farm profitably. To ensure continued profitability at the enterprise level, a farmer must maintain a balance between output and costs.
RECORDS
It is essential that a farmer must keep adequate records. These records, of both the physical and the financial situations, should enable the farmer to do spot checks on the performance of the dairy herd and to analyse the financial records that relate solely to the dairy enterprise. The gross margin system of analysis can be used for this purpose.
PHYSICAL RECORDS
For a dairy enterprise the physical records would include:
Livestock and crop production records
-
opening and closing livestock numbers
-
sales
-
purchases
-
livestock slaughtered for house and labour use
-
deaths and losses
-
births
-
feed consumed i.e. purchased feed and home produced feed
-
value per unit
-
other records appropriate to good herd management such as milk production. An example of a livestock record sheet is given at the end of this leaflet.
Crop and pasture production records should include
An example of a crop and pasture recording sheet is given at the end of this leaflet.
Stocks on hand inventory
The stocks inventory must make provision for purchased and farm-produced stocks. The following information is required:
An example of a stocks on hand recording sheet is given at the end of the leaflet.
Fixed improvements inventory
-
type of fixed improvement i.e. dairy parlour, feed shed, hay barn etc.
-
its capacity
-
its function
-
its book value, and its market-related value.
Vehicles, implements and equipment inventory
-
item name
-
its size
-
year of purchase and price
-
present book value and market value
-
fuel usage and electricity usage
-
servicing particulars
-
serial number and registration.
Labour records
FINANCIAL RECORDS
To give a complete system of financial records is beyond the scope of this guideline. However, a brief discussion is given on the minimum financial records required to perform a gross margin analysis and to determine a net farm income and farm profit.
A record of income and expenditure must be kept each year. The simplest and most effective means of keeping financial records is by using a 32 column cash analysis book.
The basis of a cash analysis book is that it deals with all money transactions. It can be expanded to include co-op accounts. From an accounting point of view, money is an asset, so the bookkeeping rule "debit the receiving account and credit the giving account" applies to the cash analysis book. Therefore, the cash analysis book has a receipts side and an expenses side. The cash analysis book is used in conjunction with the physical records to determine a gross margin, net farm income, and farm profit.
If a dairy farm has other enterprises, it would be advisable to allocate sets of columns on the receipts and expenses sides to the different enterprises. This will aid in allocating receipts and expenses to the different enterprises when determining gross margins.
ENTERPRISE ANALYSIS
When individual farmers are compared, it will be found that some achieve far better results than others, even under similar conditions and using the same resources, or even less. This reflects the standard of husbandry and management. Thus, attention must be given to those details which affect profit i.e. output and costs. It is important to consider output in relation to input levels since where inputs are low, less than average yields may produce reasonable profits. Therefore, the situation to avoid is where high costs are associated with moderate or low yields.
To avoid a situation of high costs and low yields, it is important to keep careful control of inputs and to monitor performance to diagnose unfavourable trends at an early stage. The practice of control and monitoring can separate the successful farmer from the unsuccessful farmer.
The aim of controlling and monitoring performance is to identify weak links in the chain of production. If a weak link exists, it must be strengthened before any other links are tackled. For example, if the nutrition of dairy cows is at fault, the improvement in herd genetics probably will not improve profits in the short run. Once the weak link has been rectified, then dairy profitability can be improved by strengthening all links simultaneously, so that one link does not again become a factor limiting progress.
A method by which the control and performance of a dairy enterprise can be analysed is by using the gross margin system.
GROSS MARGIN SYSTEM OF ANALYSIS
For the purposes of defining a gross margin, it is assumed that a farm has a given set of resources i.e. land, labour, capital and management and that the decision to be made is how to utilize these "fixed" resources, or costs, over the next production period, usually one year. These costs are divided into two groups i.e. fixed and variable costs.
The gross margin of an enterprise is the output of the enterprise less the variable costs attributable to it. The variable costs and the fixed costs each have distinct features.
Variable costs
Variable costs have to satisfy two criteria; they must be specific to a single enterprise, and they must vary approximately in proportion to the size of the enterprise. Therefore they only occur if production takes place.
Examples:
Fixed costs
These are costs which cannot easily be allocated to the different enterprises on the farm and do not change if the size of the enterprise is altered.
Some examples of fixed costs are:
-
fuel and repairs (although strictly these are variable costs, they are difficult to allocate)
-
regular labour costs
-
telephone, insurance and bank charges
-
costs of fixed improvements.
Output
Output in a dairy enterprise consists of:
The trading (capital) income is calculated as follows:
Trading income = (End of year value + value of slaughtered stock + value of sales)
less (beginning of year value + value of purchases).
Now that output, and fixed, and variable costs have been defined, these concepts can be used to determine the gross margin. Table 1 contains an example of determining a gross margin.
The total gross margin must service the fixed costs. By subtracting the total fixed costs from the total gross margin the net farm income is obtained.
Table 1. An example of dairy gross margin
Income:
Milk sales
Trading income |
R 280 000
28 000 |
Total |
R 308 000 |
Variable Costs:
Purchased feeds:
Concentrates
Hay
Total
Home produced feeds:
Silage
Ryegrass
Kikuyu
Japanese radish
Total
Total feed costs
Other variable costs:
Marketing
Veterinary & A.I.
Transport
Labour
Cartage
Miscellaneous
(Udder wash, ear tags etc.)
Total |
R 80 000
1 000
R 81 000
R 13 000
22 000
22 000
5 000
R 62 000
R 143 000
R 30 000
8 000
25 000
12 000
5 000
6 000
3 000
R 89 000 |
Total variable costs |
R 229 000 |
Total gross margin |
R79 000 |
NET FARM INCOME AND FARM PROFIT
Net farm income represents the return to capital and management. Consequently finance and interest charges, rent and costs of the management input of the farmer are not included in the fixed costs.
If a farm has a number of enterprises then the net farm income is obtained by subtracting total fixed costs from the sum of the gross margins for all the enterprises. Figure 1 gives a diagrammatic picture of the net farm income for a mixed dairy farm.
The farm profit is determined by subtracting external factor costs. These external factor costs are costs of the production factors that are not owned by the farmer, namely rent on hired land, interest on borrowed money, and salaries of hired farm management.
An example of a farm income statement is given in Table 2, and shows how the total gross margin, net farm income and farm profit are determined. A good record keeping system should be able to provide at least an income statement, and a gross margin analysis for each enterprise.
FACTORS AFFECTING DAIRY PROFITABILITY
The gross margin analysis allows a farmer to analyse each factor contributing to the gross margin. The main factors influencing the profitability of milk production are shown in Figure 2. Although the gross margin only includes variable costs, the appropriate share of the farm's fixed costs (labour, fixed improvements, machinery etc.) must also be considered.
From Figure 2, it is obvious that the fundamental challenge for the producer is to combine yield, incomes and costs to the best advantage according to circumstances on the farm. Therefore, it must be remembered that no one system of dairy farming can be applied universally i.e. what is best for one farm is not necessarily best for another. However, the same general principles apply, and the milk producer needs to have a firm grasp of them if he is to formulate sound answers to the many management problems.
YIELDS AND COSTS
In general, the highest gross margin is obtained from high yield levels, but if high yields are associated with high costs, then they do not produce high gross margins.
Yield, fixed costs and profits
The relationship between yield and fixed costs is given in Figure 3, from which it is evident that the greater the yield per cow, the less the fixed costs per litre. It is also clear that one can gain a greater reduction in fixed costs per litre by moving from low to moderate yields, than by moving from moderate yields to high yields. Therefore, the higher the fixed costs per cow, the more important it is to have good yields.
Table 2. An example of farm income statement in vertical form for the year ended 28th February 19X1
| Year |
19X1 |
19X2 |
| Income (a) |
R 300 000 |
R 200 000 |
Crop sales - Maize
Wheat
Livestock:
Dairy trading income
Product income
Other farm income |
80 000
40 000
8 000
152 000
20 000 |
60 000
26 000
4 000
96 000
14 000 |
| Expenditure (c) + (e) + (g) = (b) |
R 270 000 |
R 178 000 |
Allocated variable costs:
Seed
Fertilizer
Pesticides & weedicides
Packing materials
Contract services (transport harvesting)
Feeds
Veterinary
Casual labour
Marketing
Insurance (crops & livestock)
Miscellaneous (crop & livestock)
Total allocated costs (c) |
4 000
40 000
10 000
12 000
4 000
20 000
3 000
5 000
14 000
6 000
4 000
R 122 000 |
3 000
22 000
6 000
7 000
2 000
12 000
3 000
4 000
6 000
5 000
4 000
R 74 000 |
| Gross margin (a) - (c) = (d) |
R 178 000 |
R 126 000 |
Fixed costs: (unallocated)
Fixed improvements (depreciation,
repairs, insurance)
Vehicles, machinery & equipment (depre-
ciation, insurance, etc. repairs & fuel)
Regular labour (wages, rations, other)
Electricity
Miscellaneous (telephone, bank charges,
professional fees)
Total fixed costs (e) |
7 000
48 000
32 000
5 000
6 000
R 98 000
|
5 000
36 000
20 000
4 000
5 000
R 70 000 |
| Net farm income (d) - (e) = (f) |
R 80 000 |
R 56 000 |
External factor costs:
Overdraft interest
Mortgage & other loan interest
H.P. interest
Rent
Management salaries
Total fixed costs (g) |
8 000
12 000
4 000
10 000
16 000
R 50 000 |
7 000
12 000
3 000
-
12 000
R 34 000 |
| Farm profit (a) - (b) = (h) |
R 30 000 |
R 22 000 |
Figure 2. Profit factors (Source: Buckett, 1981)
Figure 3. Yield and fixed costs
Another way of looking at fixed costs is to consider the quantity of milk that must be produced in order to cover the fixed costs i.e. break-even analysis. The break-even output is determined as follows:
Total fixed costs (R/cow)
Break-even output = -----------------------------------------
Receipts/litre less variable costs/litre
This is illustrated in Table 3.
Thus, from Table 3 the break-even output is:
Break-even output = 1427 X 100 = 3857 litres/cow
(per cow) (80 - 43) /year
Thus, in the above case 73 per cent of total production per cow (3857 litres out of 5300 litres) is required to break even, while the remaining 1443 litres gives rise to the net profit of R 544 per cow.
From this analysis, it is evident that the fixed costs can influence a farmer's yield target. Therefore, farmers who have high fixed costs tend to have greater pressure on them to aim for high yields. Profits can be made at high fixed cost levels, provided that output is sufficient.
Table 3. Costs and returns in milk production per cow
| |
per cow |
| Receipts 5300l/cow at 80c/l |
R 4 240 |
Fixed costs:
Depreciation
Fuel and repairs
Regular labour
Interest*
Miscellaneous (telephone etc)
Total fixed costs (including interest)
Variable costs:
Purchased feeds
Home produced feeds
Veterinary & A.I.
Transport
Marketing
Miscellaneous
Total variable costs
Total cost
Profit per cow |
353
419
408
135
112
1 427
1 222
605
153
132
115
42
2 269
3 696
544 |
Receipts per litre (product income per litre)
Variable costs per litre |
80 c
43 c |
If a farmer cannot reduce his fixed costs , then his total costs can be reduced by greater efficiency in his variable costs, e.g. making better silage, better hay, ensuring that the appropriate rations are fed at least cost. The dairy farmer could also improve the potential of his cows by better management, disease prevention and greater attention to detail.
The point at which to stop increasing yield is when diminishing returns result, i.e. the marginal revenue equals the marginal cost of producing the last unit of milk, assuming that cow intake allows it, and that other related problems do not occur first.
Yield and variable costs
The break-even formula used above is a good guideline. However, it is over-simplified in that it assumes constant average variable costs from litre to litre so that maximum yield per cow is always most profitable.
Variable costs actually increase as yield increases because:
-
the efficiency of feed conversion declines as a cow approaches her milk production potential
-
the ration has to become increasingly concentrated if she is to consume sufficient nutrients for high yields.
Therefore, it is important that the interaction between income (yield) and variable costs is cleary understood. Again, the producer should increase yield to the point where the cost of additional food is just covered by the value of the additional milk. However, the extra milk should pay for the extra food without diverting scarce working capital from other and better opportunities.
Variable costs consist mainly of feed and labour costs. Feed accounts for about 50 to 60% of the cost of production. Labour accounts for about 10 to 20% of production costs.
The cost of feeds
Feed can be classified as follows:
-
purchased feeds; and
-
home grown feeds
The purchase price plus delivery charges is the cost of the purchased feed that is allocated to the dairy.
Homegrown feeds, unsaleable but grown especialy for the dairy, are allocated to the dairy at production cost e.g. production cost of ryegrass, Japanese radish.
The saleable homegrown feed should be valued at the anticipated selling price, if it could be sold, had there been no dairy cows on the farm. Therefore, the crop is essentially a cash crop, and its cost is the value of sales forgone. However, if the crop is grown only because there is a dairy herd, the real cost allocated to the dairy is the gross margin lost by not growing the next best alternative crop.
It is evident, from Figure 2, that feed costs per cow depend on the combination of homegrown forage costs and concentrate costs. To ensure that feed costs per cow are kept low, the farmer needs to analyse three important areas of nutrition which influence margins (income) over feed costs, besides those others mentioned in Figure 2. These are:
-
the cost of feed ingredients
-
the quality of the ingredients used in rations
-
feeding the proper rations at the proper times.
With regard to the cost of feed ingredients, it is important that costs of feed ingredients e.g. c/unit Metabolizable Energy (ME), c/kg CP etc. are not considered on their own, but that the cost of the ration as a whole is considered on the same basis. For example, compare the cost of crude protein (CP) in two feed sources. One contains 400g/kg CP and the other contains 300g/kg CP. The cost per kilogram CP from each of them is given in Table 4.
Table 4. The unit costs of protein from two feed sources, and the costs of mixing a ration using these sources
| |
Cost/t
(R) |
CP
g/kg |
Cost of
CP
(c/kg) |
40% CP
30% CP |
1000
825 |
400
300 |
250
275 |
|
Cost of mixing a 150 g/kg ration
using the 40% CP source |
| Ingredient |
kg |
R/ton |
Cost
(c/kg) |
|
Maize meal
Protein (40%)
Bone meal
Salt |
78,0
20,0
1,0
1,0 |
500
1000
1130
210 |
39,00
20,00
1,13
0,21 |
|
Total |
100,0 |
|
60,34 |
Cost of mixing a 150 g/kg ration
using the 30% CP source |
| Ingredient |
kg |
R/ton |
Cost
(c/kg) |
|
Maize meal
Protein (30%)
Bone meal
Salt |
68,5
29,5
1,0
1,0 |
500
1000
1130
210 |
34,25
24,34
1,13
0,21 |
|
Total |
100,0 |
|
59,93 |
Therefore, on the basis shown in Table 4, the 40% protein source is the better buy as there is a saving of 25c/kg CP. However, if the two feeds are compared on a total cost basis in a balanced ration containing 150g/kg CP the balance turns in favour of the 30% protein source.
It does not imply that the first two calculations are incorrect in showing that the 30% protein source is more expensive. What the calculations costing protein per unit fail to show is the proportions required of each relative to their prices in each ration.
A further important consideration is the quantity of each ration, in relation to other feeds required by a cow, to complete her daily requirements. This, in turn, could tip the scales in the other direction, thereby making the 40% protein source the cheapest overall.
Thus, other feeds,like kikuyu, ryegrass, Eragrostis hay and maize silage, need to be considered not only with respect to the quantities required to satisfy a cow's daily requirements, but the quality of these feeds needs to be carefully analysed as well, as the quality of the pasture will determine the quantity of the ration required. The quality of the pasture therefore has a direct bearing on total cost of the ration. Consider four different proportions of roughage and maize grain required to produce a ration of 10,5 MJ ME/kg DM. The ration is capable of satisfying the needs of a 500 kg cow producing 20 litres of milk at 3,75% BF.
The four roughage qualities (MJ/kg DM) used in figure 4 represent the following feeds:
| 7 |
- |
Veld hay, wheat straw |
| 8 |
- |
Eragrostis hay, veld grazing |
| 9 |
- |
Kikuyu, Smuts finger grass
Coast cross II, Sorghum |
| 10 |
- |
Ryegrass, maizes silage |
From Figure 4, it is evident that as the roughage quality improves, the less maize grain (concentrate) needs to be used. Figure 5 shows the effect of roughage quality on the total feed cost. The difference in ration costs when using a poor roughage or a good quality roughage can be of the order of 100%. Therefore, from Figure 5, considering only feed, and a 20 litre production, a margin over feed costs of 39c/l is made using a 7 MJ/kg DM roughage, while 48c/l is made using a 10 MJ/kg DM roughage.
Other variable costs
Artificial insemination fees may appear to be expensive, but A.I. is cheaper than using bulls, and is the key to rapid genetic improvement. The cost of keeping records is rewarded by their value to management. Transport costs are dictated by the distance from the market.
|
Figure 4. Proportions of roughage and maize to produce a ration containing 10.5 MJ/kg DM
|
Figure 5. Relative cost of producing a ration of 10.5 MJ/kg DM
|
Veterinary fees can be kept to reasonable proportions if suitable disease preventative measures are adopted on veterinary advice, and treatment of stock is undertaken promptly. It has been found that farmers with high-yielding herds spend more on herd health and reproductive programmes than do farmers with low-yielding herds. This implies that regular veterinary visits are worthwhile.
MANAGEMENT
From the foregoing discussions it becomes evident that good management and management ability are key factors in making a profit in dairy farming. Management has many facets relating to husbandry, production and to economic aspects.
Participation in some form of group recording scheme can help control the dairy enterprise and thus help the management process. The competition arising from group discussion and from comparison can be a useful stimulant to achieve higher goals.
The scheme should include a physical forecasting element, and a financial element. Thus, information such as calving dates, ages of cows, yield, lactation period of past and current lactations and inter-calving period is required from the farmer. The forecast can be presented in graphic form and, when actual levels deviate from predictions, the farmer's attention is drawn to the problem and he can endeavour to establish reasons for the deviations.
EFFICIENCY MEASURES
There is much confusion over which measurement of profitability should be used when analysing different systems of dairying i.e. cents per litre, rand per cow or rand per animal unit, rand per cow per day, rand per hectare etc. Assuming that a farmer is aiming to maximise profits, the efficiency measure should be determined according to the most limiting resource available, be it land, labour or capital. Therefore, on a small farm profitability per ha is the most important measure, while profitability per R100 capital invested, may be more important on a large farm.
Gross margin per litre
Different efficiency measures are given in Table 5. It can be seen that measuring profits in terms of cents per litre is very misleading.
It is evident from Table 5 that cents per litre do not give a true evaluation of the three situations since the top farmer with a gross margin per AU of R1 777 is making the same gross margin in cents per litre as is the farmer with a gross margin per AU of R1 651. Table 6 illustrates why cents per litre may be misleading in determining true profitability.
If the farms in question had hectares feed crop as their limiting factor then Farmer 3 would be the most efficient since his gross margin per ha feed crop is the highest. However, since all farms vary in size, and since capital is usually the limiting factor, the usual performance measure for comparison purposes is Rand per cow or Rand per AU.
Table 5. Gross margins of three dairy farms showing that profits in cents per litre can be misleading
Farmer
Average no. AU's |
1
220 |
2
196 |
3
226 |
Gross Income (R/AU):
Trading Income
Milk (product)
Total
Allocated variable costs (R/AU):
Purchased feeds
Farm produced feeds:
Concentrates
Greenfeed
Silage
Pasture
Total feed costs
Other variable costs:
A.I & veterinary
Marketing costs
Transport
Other costs
Total allocated variable costs |
344
2 710
3 054
997
-
-
22
383
1 402
90
49
50
42
1 633 |
408
2 680
3 088
535
20
24
132
415
1 126
85
58
16
152
1 437 |
640
2 813
3 453
898
-
-
-
523
1 676
81
137
222
15
1 676 |
Gross margin (R/AU)
Gross margin/litre milk (c/l)
Gross margin/ha feed crop (R) |
1 421
35
1 495 |
1 651
42
1 375 |
1 777
42
2 692 |
Source: Natal Finrec Dairy Farmers Data
Table 6. Gross margin cents per litre
| |
Farm A |
Farm B |
| Average number of cows in herd/month
Average number of cows in milk/month
Average litres/cow in milk/day |
100
80
17,2 |
100
80
13,5 |
| Total litres per month
Milk income at 80c/l
Feed costs/month
Other variable costs |
42 000
R 33 600
R 14 000
R 5 000 |
33 000
R 26 400
R 6 800
R 5 000 |
| Gross margin (R/month)
Gross margin (cents per litre)
Gross margin (Rand per cow in herd) |
14 600
34,76
146,00 |
14 600
44,24
146,00 |
From Table 6 both farmers have invested in 100 cows. However, their average litres per cow in milk per day is different, but they have the same gross margin per month. Furthermore, it is shown that Farmer B has the better gross margin per litre while having the same gross margin per cow in the herd. The distortion arises because the same gross margin is divided by a smaller volume, hence a larger gross margin per litre. Thus, the figure, rands per cow in herd, gives a true reflection of the profitability of each farm.
From the foregoing discussion, it is apparent that it is very important, when comparing profitability, that the underlying factors of producing milk are known. This will ensure that profitability is compared on the same basis.
Margin over concentrates (MOC)
The MOC is a valuable indicator of the ongoing financial performance for the individual herd.
However, in comparing the performance of different herds, it has little meaning unless the calculation of MOC's for the comparisons is done on the same basis.
The factors determining MOC are milk sales and concentrate feed costs. Purchased feeds, used as an alternative to concentrates, should be included as part of concentrate feed costs.
A farmer has three options in achieving high MOC. These are:
-
to increase yield without commensurate increases in feed costs
-
to reduce feed costs without reducing yield
-
to increase yields with lower feed costs.
The latter is possible by ensuring above-average stockmanship resulting in good yields with above-average pasture management resulting in good-quality pastures.
In comparing the MOC of one farm with other farms, it cannot be over stressed that the underlying factors of producing milk must be known, otherwise, as in the case with gross margin per litre, wrong deductions can be made with regard to performance. When assessing the MOC, it is important to take into account the stocking rate together with the level of expenditure on forage crops, and the fixed costs associated with the production of the forage.
To emphasise the significance of MOC as an efficiency measure, it is necessary to emphasise the main factors resulting in a good margin. The main factor contributing to a good MOC is the quality of the grazing on the farm. This has a twofold effect i.e. good quality grazing lowers the feed costs, and it helps in attaining good yields. Thus, the achievement of a good MOC depends on how well these factors are controlled and implemented on the farm.
FURTHER READING
BUCKETT, M. 1981. An introduction to farm organisation and management. Pergamon, Oxford.