PRACTICE MANAGEMENT

Clients use our services when they perceive them as valuable. Nothing real profound with that statement, but it contains the truth that we must capture in order to grow our business even as our customer base shrinks. The most successful practitioners constantly seek new ways to provide value to their clients.

Financial management is one aspect of dairy farming where many clients can use help. This is not to say you will replace their accountant, but you can help them interpret their financial statements and in turn help them make improvements in their animal management that are financially helpful. One key number that producers should understand is EBITDA, which stands for "earnings before interest, taxes, depreciation and amortization."

Another term for EBITDA is "operating profit." This refers to the profit (or loss if it is a negative number) that results from simply operating the business, without regard to investment or financing.

This is important to know for two reasons.

• One, it allows a manager or his or her advisor to evaluate financial performance solely on the basis of current operations.

• Second, it is crucial to planning expansion or refinancing.

Before proceeding, let's take a minute to discuss the terminology. Earnings are the difference between income and expenses. Interest is the money paid to lenders for money that is borrowed. Taxes refer to income taxes, but not real estate taxes. Depreciation is a number used to designate the declining value of assets that become obsolete or "worn out." Amortization refers to changes in debt.

Since the letter "B" stands for "before," EBITDA means the money left after paying routine operating expenses, but before addressing expenses associated with financing or ownership.

Case in point

Now, let's consider a real-life situation. A good client seems quiet and a bit depressed as you do routine herd exams. You do a bit of probing, and he confesses that he is having trouble paying his bills, and is worried if he will be able to survive. (This conversation was much more likely to have happened a year ago than today!) He wonders what he is doing wrong.

From your point of view, you know that he ships a lot of milk per cow, and that health is relatively good in his herd. You are surprised that he is in a financial bind, because you considered him a good manager. What can you do to help?

If he is willing to open his books to you, you can begin by helping him compute his EBITDA, and then convert it to a per cow basis.

With smaller farms, you must adjust by subtracting family draws in place of labor. Good managers will average between $600 and $800 per cow, and some will be more than $1,000 per cow. In times of good milk prices, this will be higher, and of course much lower when milk prices are poor. Poorer managers tend to be in the $200 to $300 range.

If your client has numbers below $500 in times of average milk prices, then there are problems in the way he is doing routine operations.

Either he is simply not shipping enough milk to generate adequate income, or his expenses are too high for the milk he is shipping. Benchmarks are available to help him see where he may be out of line. Feed and labor are common culprits.

If EBITDA appears to be in line with superior managers, then your client is doing a good job of managing day-to-day operations. In this case, problems with cash flow probably result from too much debt, or too aggressive a payment schedule.

Sometimes managers structure debt for rapid repayment, believing that debt is inherently "bad," and so strive to become debt free as soon as possible. That is fine if they can do it, but it can be a deathblow in times of mediocre milk prices.

Structuring loans

Loan structures should really reflect the life of the asset they are used to finance. For land, 30 years makes sense, because land will not have to be replaced. In addition, the return from owning land is poor unless it appreciates in value, and such appreciation is not available in cash unless it is sold. For buildings, 15 to 20 years is reasonable.

Equipment wears out much sooner, so five years is generally acceptable for equipment. Cows represent a unique situation, because they produce their replacement. If the cost of replacements is included in the operating expenses, then cost of the original cows can be depreciated over many more years than the productive life of the average cow. Banks often go with seven years on cow financing.

Work to change

Once you have some understanding of EBITDA on your client's farm, you can begin to work with him on management changes to improve it, or on debt restructuring if that is where the problem lies. You may need to make a change in one area to improve another. For example, borrowing money to pay for stall improvements can rapidly lead to higher production and lower culling. This exchange can have a dramatic impact on improving cash flow and profit.

This column has considered a situation where a dairy practitioner can provide value to a client having trouble with cash flow. Keep in mind that the client will have to do something different for improvement to come. Just reviewing records is useless unless it leads to productive change.

From your point of view, you will help your own bottom line if you charge a fair fee for your time and knowledge. The amount you will charge will be only a fraction of the value you provide to a competent manager. You will further help your own cause by helping your client stay in business, and thus remain a source of income for years to come. All in all, this adds up to a win-win.