Dairy farm financial statements: Understanding benchmarks

February 21, 2020

Never before has strong farm financial management been more important than it is today. Or as challenging. In addition to planning and monitoring all the moving parts of a farm's operations, knowing where you stand financially equips you to make the more informed business decisions. To help you do this, you need to understand and analyze your financial statements.

BDO's agriculture accountants are using standardized farm financial statements created to be more practical and useful for farms. They allow you to compare year-over-year results, to focus on what can be improved, dig into details and discuss plans for the future.

Benchmarking against results

What is benchmarking? It's the process of evaluating something against a standardized comparison. Our financial benchmarking tool for farm management looks at financial results over five years along with data from a regional client base.

BDO's financial benchmarking management tool was developed to provide guidance that supports financial statement analysis. Data is only as valuable as the decisions it enables. This is why our team strives to deliver the most relevant data that supports strategic future planning.

Once a benchmark is chosen for analysis, data is extracted to show results. Information is presented in charts with a chosen benchmark trend line to show the comparison. All charts can be shown as a percentage comparison, dollar per kilogram of yield or quota, or as a dollar-to-dollar comparison.

Understanding the farm financial statement

Originally, Dr. Larry Martin created the standardized statements as a way to do analysis for his CTEAM program at Agri-Food Management Excellence. He organized the farm financial statement on two principles:

  1. Managing operations is different from managing capital and finances, so it's organized to reflect those areas independently
  2. All farms, no matter what commodities they produce, have five standard sets of costs

Items included as farm revenue

INCLUDES:
  • Sales from farm production
  • Gains/losses from legitimate hedging programs
  • Crop insurance payments
DOES NOT INCLUDE:
  • Government program payments (except crop insurance)
  • Earnings on investments
  • Gains/losses on disposals
  • Off-farm work
  • Other non-farm income

Cost category breakdown for financial statements

Five cost categories for farm financial statements are segmented within two types: costs for operating, and costs for financing.

OPERATING COSTS
  1. Cost of goods sold
  2. Direct operating expenses
  3. Overhead expenses
FINANCING COSTS
  1. Capital related costs
  2. Interest

Operating costs are based on the nature of agricultural production. This production encompasses converting raw materials into final products and using labor and equipment to produce and transport inputs and products.

Financing costs account for the annual cost of capital and interest.

  1. Cost of goods sold: Items farms buy to transform initial inputs into intermediate and final products. Examples include converting seeds, with the help of fertilizer, pesticides, etc. into forage, grain and produce. With livestock, this consists of transforming offspring of parent animals, with the help of feed, medicines, etc. into meat, eggs or dairy products.
  2. Direct operating expenses: Costs associated with activities directly involved in operations. These expenses include operational labor, fuel, custom work, repairs and maintenance, utilities, small tools and supplies, and transportation costs.
  3. Overhead expenses: Also referred to as fixed costs; costs not directly related to production and transportation. These include office and administrative expenses, advertising and promotion, staff salaries, insurance, and professional fees.
  4. Capital-related costs: Also known as depreciation/amortization/financing, this is the costs of accessing capital assets like machinery, land, buildings, and quota. Capital-related costs include the depreciation and amortization of machinery and buildings, leasing and rental costs of capital assets, land clearing costs, and property taxes.
  5. Interest: Interest on short- and long-term financing. We include gains/losses on sales of capital or investments in the ‘other income and expenses' section of the financial statement. This part of the statement does not include bank charges.

How to apply cost categories as benchmarks

Each cost category can be compiled, analysed, and treated as a benchmark for comparison. Farmers can choose to compare results with their own data year over year, or with regional benchmarks and their associated five-year averages. These comparisons give a practical view into what numbers look like and how they should look to maintain a successful progression.

A higher percentage or dollars per kilogram of dairy quota spent in certain categories can indicate areas where further analysis is required. This analysis creates an opportunity for discussion and is where our team steps in to offer guidance. This is also an opportunity to identify red flags, if they exist, and to take the necessary steps to bring things back to a steady and profitable state.

Let's use an example to demonstrate how using contribution margin per kilogram of quota as a benchmark can help determine whether a kilogram-of-dairy-quota purchase could be profitable:

Farm X is a 115 kilogram-of-dairy-quota farm and also grows grain and oilseeds. Let’s assume that the quota cost is $24,000 per kilogram with a 4% loan interest rate. If we were to add 5 kilograms of quota without any additional equipment or labour, how could that increase income?
Before additional acreage
Contribution margin of 115kg @ $3,380/kg $388,700
Fixed overhead costs -$65,000
Fixed capital costs -$250,000
Income before other items and taxes $73,700
After adding 5 kilograms of dairy quota
Contribution margin of 120kg @ $3,380/kg $405,600
Fixed overhead costs -$65,000
Fixed capital costs -$250,000
Increase in interest: $120,000 @ 4% -$4,800
Income before other items and taxes $71,300
Increase of Income Before Other Items and Taxes $85,800

Looking at a fixed contribution margin per kilogram as the above example benchmark, we see the additional 5-kilogram purchase could increase income by $12,100 per year on those parameters alone. However, the income per kilogram also includes cattle sales and crop income. The direct expenses on average per-kilogram of additional expenses would likely decrease: logic would say one more cow won't likely increase the diesel or the labor used, so contribution margin may improve. More questions and answers are needed to understand the true implications of this change but this is a good starting point.

This tool has the potential to show how making improvements, no matter how small, can impact a farm's financial strength. Our team of advisors can discuss the potential changes your farm can make to benefit your financial health or improve operational efficiency so you can understand the other factors.

How benchmarks and standardized statements can help your farm grow

You can't manage what you don't measure. Whether you've recently transitioned into a farming operation or have been running your family farm for generations, our standardized farm financial statement and benchmarking tool can help gauge your position and suggest improvements. Our team would be happy to discuss this with you and answer any additional questions.