Possible scenario for dairying bottom line
Only a brave or foolish person would try to put numbers down for dairying's next two years.
The last month or so has shown how volatile milk markets can be as we all got a firsthand look of the see-saw effect of supply and demand.
Who knows what the dairy farming financial picture might look like for the next two years ending May 2016?
Let's cast aside any fears we might of getting it wrong and take a look at a possible scenario based on a typical, well developed and sound Canterbury owner- operator dairying couple with scale.
For the sake of the exercise, both partners are working fulltime in the business and feel the information they have received for the current season's payout plus milk retrospective payments would look to be about $6.50 a kilogram of milk solids, but the year to end May 31, 2016, could perhaps be much lower.
Let's look at the effect using a $5.50 kg/ms payout including all and any retrospectives to see what effect this might have on the balance sheet.
The bottom line is that our dairying couple could come out of the 2014-2015 season on a hypothetical $6.50/kg payout with 37c/kg possibly for debt reduction, farm development, capital spending and/or improved working capital.
The scenario for the 2015-16 season would be less palatable as they might face a loss of 8c/kg after farm expenses, interest and rent, depreciation, drawings and income tax are removed. This might come after pruning farm expenses harder than the year before.
Of course, every dairy farming couple is different and they will have different data. Some farmers will most certainly pull back more on certain farm working expenses as we saw in the 2009 year.
The break-even position for the above example in the 2016 year is about $5.60/kg. At a payout of about $5.50/kg the graph would suggest that government tax receipts from dairying will be small and nil in many cases. It's worth noting that the dairying industry has been a big income tax contributor for most of the last 10 years.
At $5.60/kg though, the 2016 example in the graph would suggest our farming couple could balance their cash flow, although only just.
The biggest weakness in the assumptions used for the 2016 year are that interest rates will be more than $1.50/kg and our farmers will be unable to hold their farm working expenses to $4.20/kg.
By far the best upside in the 2016 year would be if there was a payout well in excess of $5.60/kg.
Farming couples in all sector groups have now had considerable practice in dealing with volatility. The dairying scene has seen this volatility in the past and within two years of the difficult 2009 year the payout moved up sharply.
In every business sector the top group always break or improve the mould in every upside and downside in their business. Sadly, the bottom 10 per cent in every business have either sold the mould or destroyed it and that is simply people and business life.
The real point though is that the 80 per cent block of business people between the top 10 per cent and the bottom 10 per cent will determine in the main what compensating action will take place on the ground in the light of a possibly much lower gross farm income in this 2016 year.
Some farming couples will focus on increasing milk production for each cow and each hectare through good management, re-grassing, better feeding. Others will focus more on reducing costs and some a combination of the two options.
Over many years it's interesting to note that I have found that farming couples tend to focus on increasing production when product prices are high and also when they are low. The possible pull backs on some of the costs referred to in the 2016 year are simply one option and there would be several possible approaches they could take.
My schedule is simply trying to show that with a few key changes, the 2016 year income and expenses at a payout of $5.50/kg may not be a long way out of balance. It must be conceded, though, that sometimes these reduced expense solutions are unable to be held for long.
Government should be taking a real interest here as the dairying income tax take on the schedule in the 2016 year will struggle to cover members of Parliament salaries, cars, travelling and perk costs.
Probably the key farm management issue is to avoid or minimise any cash loss arising from the lower payout - minimising your loss is just as important as maximising your profit.
Lastly, we have seen all this before several times over and making hay (that is good profits) when things are going well and making good use of it always carries the day.
* Pita Alexander is a specialist farm accountant at Alexanders.