Fortunately, milk prices have also increased so that we still have the opportunity for profitable margins. Yet we don’t want to be complacent on our situation.
While it can feel like there isn’t anything we can do about rising costs, there are some steps that we can take as managers to focus on areas that we can control, and prepare for the things we can’t. Strategies to be successful through the current period of increased prices and costs include the following:
1. Continue to Increase Productivity. As prices for feed and other inputs rise, we can be tempted to simply cut back on purchases. While we want to negotiate prices and evaluate purchases, we don’t want to detract from growth in our per cow productivity. Our best avenue to increase revenue and spread out production costs is to invest in cow care, genetics and high-quality forage and feed ingredients to increase per cow and whole herd production.
2. Extend Risk Management Coverage. Milk price forecasts for next year are favorable with Class III and Class IV prices well above historical averages. While there is reason to be optimistic on milk prices, there are always factors beyond our control that could cause milk price to drop unexpectedly. Think about a disruption in exports, for example. As we buy and lock in higher cost fertilizer, seed, feed and other inputs for 2022, be sure to get price floors in on milk price. Every farm should have Dairy Margin Coverage in place at the $9.50 margin level for up to 5 million pounds and we strongly encourage DRP coverage on at least part of your production through all four quarters of 2022.
3. Fix Interest Rates on Term Debt. Short term and variable interest rates have been at a low level for an extended period which has helped on interest costs on our farms. Market indications are for variable rates to rise in the coming year. Fixed rates on term debt have also started to increase but are still favorable. If you have variable or short-term rates on your term debt, this may be a good time to extend the fixed-rate coverage. That particularly applies to land purchases where higher rates can impact the cost of land ownership.
4. Prioritize Capital Expenditures. Increased costs are also causing the price of new buildings, building improvements and equipment to go up sharply. We still need to reinvest in our business but need to focus our capital budget on those investments that generate the highest return. That is likely going to be those investments that increase cow care productivity as well as enable our workers to be more efficient. We may need to put off some capital purchases that don’t have as a high of a return.
5. Balance Debt Structure. As we buy new equipment or improvements, we may be tempted to use a shorter loan term to obtain a lower interest rate. We need to balance the goal of lower interest rate with the need to keep our annual debt service obligations manageable in the event profit margins get squeezed. We may want to choose longer loan terms to reduce the annual principal payment demands. A guideline is to keep annual principal, interest, and capital lease payments less than $2.50 per cwt. of energy corrected milk production.
6. Maintain Working Capital. Our backstop to prepare for the things we can’t control is to maintain solid working capital levels. We want to make sure that payables are current and that we have plenty of availability in our operating lines and other revolving lines of credit so we have a cushion if things don’t going according to plan.
It does appear that we will be working through higher expenses for most if not all of the coming year. We do have a number of steps that we can take to manage through these costs and continue to generate profits on our farms. With the new year beginning, now is the time to act on the areas we can control and continue to prepare our financial position to be ready for the unexpected.