Hoard's Dairyman: It isn't business as usual

From article

“It isn’t business as usual”,

July 2010 Issue, page 469

David Kohl is professor emeritus of agricultural finance and small business management at Virginia Tech, Blacksburg, Va. As owner of AgriVisions, he continues to advise businesses.

Gary Sipiorski is the dairy development manager for VitaPlus of Madison, Wis. He is a member of the board of directors with Citizens State Bank of Loyal, Wis.

What is the correct liquidity ratio?

Kohl: I recommend using the working capital-to-revenue ratio. The old current ratio is becoming antiquated as operations become larger and more complex. Let’s look at it with a stop-and-go-light analogy.
Green light: Greater than 33 percent — If the producer has high debt levels, is moving into a major expansion, or is coming off a profitable cycle in the industry along with a good risk management program for young producers.
Yellow light: 10 to 33 percent — If higher equity above 70 percent or coming off a down cycle in prices, such as recently.
Red light: Less than 10 percent — Either extremely high equity more than 85 percent, a great risk management program, or frugal living.
Working capital can take a number of years to build up only to be used up in 6 to 10 months like during the last down cycle. With higher volatility in milk prices and input costs, this metric will become more important.

Sipiorski: A dairy operation should have $2 of current assets for every $1 of current liability. That would be called a 2:1 ratio. This means there should be two times the amount of current assets of cash, feed, and other current assets which will be turned into cash in the next 12 months compared to the current liabilities of bills owned and principal due in the next 12 months. A 1.5:1 ratio is about as skinny as dairy should go. This may seem like a lot of liquidity. But this is a safe level; think about how this kind of liquidity would have felt in 2009.

Where does return on operating expense need to be on a good operation?

Kohl: I also like the operating expense to revenue ratio (excluding interest and depreciation or corporate management fees). As for benchmarks:
• Green Light: less than 70 percent
• Yellow Light: 70 to 85 percent
• Red Light: more than 85 percent
Thus, top level producers will have 30 percent margin. However, examine this over the years and through the cycles.

Sipiorski: On most dairies, an 85 percent expense rate is as good as it is going to get with the current market conditions. If it is possible for a dairy to lower their expenses below 85 percent, they will be a winner over others. Today’s economics does not seem to be allowing dairy producers to capture any more than a 15 percent return.