Your finances tell you how competitive you’ll be

The Ohio State University Dairy Excel 15 Measures of Dairy Farm Competitiveness bulletin is designed to assist dairy farmers and advisers in understanding financial performance measures. This article will describe Measure 3, Cost Control: Operating Expense Ratio.

This ratio indicates the percentage of the gross farm income used to pay operating expenses. To be competitive, expenses, not including interest, should be less than 70% of gross farm income. When this ratio is below 70%, more money is available for principal and interest payments, family living, improvements, and savings.

The ratio is calculated by subtracting farm interest expenses from total cash operating expenses, dividing by gross farm income and multiplying by 100.

Example

Assume a dairy farm has $1,088,000 in expenses, $52,000 in interest, and $1,450,000 in gross farm income. What is the Operating Expense Ratio of this farm? Example calculation:

   $1,088,000 expenses

– $ 52,000 interest

= $1,036,000 operating expenses

$1,036,000/$1,450,000 = .71 X 100 = 71% Operating Expense Ratio

To determine your operating expense ratio, take your Form 1040 total cash operating expenses for the year being analyzed and make these accrual adjustments as needed:

–  Subtract the depreciation expense from Form 1040.

–  Subtract expenses that were prepaid for future production.

–  Add expenses that were prepaid in the previous tax year for items that were used to produce milk in the year being analyzed.

–  Add expenses for items that were used to produce milk but were not included on Form 1040. This includes unpaid bills.

–  Subtract any expenses that were paid in the year being analyzed for items used in previous production years.

Gross farm income

Gross farm income includes cash from income adjusted for changes in inventories from year to year. For example, if your livestock inventory numbers are the same as the previous year, except for five additional springing heifers worth $10,000, add this $10,000 to gross farm income. If you have $20,000 less feed on hand than in the previous year, reduce gross farm income by $20,000.

If your operating expense ratio is less than 70%:

–  Assuming expenses are below 70% and production per cow is above that for similar animals, great!

–  If expenses are low, income is low, and cash is tight, the business may not be big enough to generate enough income. Too much debt might also be an issue. Examine your current ration and debt-to-asset ratio for clues.

If your operating expense ratio is above 70%:

–  This may be the result of high expenses, low income, or both. Make sure your feed costs per cwt of milk sold are reasonable.

–  Are expenses out of line or possible reported in the wrong year?

–  Low gross farm income can also push the operating expense ratio above 70%. Look at your asset turnover ratio, milk sold per worker, and investment per cow for signs as to why the ratio is high.

Summary

Looking for ways to minimize and control costs on your dairy is a constant task. In addition to the Dairy Excel 15 Measures of Dairy Farm Competitiveness bulletin, I encourage you to learn more about the OSU Extension Farm Business Analysis and Benchmarking Program at https://farmprofitability.osu.edu/.

This program utilizes the FINPACK program to analyze farm production records by whole farm and at the enterprise level. It’s an outstanding program and can teach you a great deal about your financial position.