Managing Profitability for Your Dairy Business
We as a dairy industry readily discuss, and often stress, the importance of margin management. Understanding cost of production, hedging/marketing strategies, and making profitable financial decisions for your dairy business are always forefront topics as producers plan for their upcoming fiscal year. In the past four years, our dairy industry has realized favorable milk prices, agricultural government assistance payments and improved other income sources like cull cows and bull calf sales. Together, this has allowed many dairy businesses to achieve levels of profitability. As profitable years come to fruition, the question of “what do we do with our profits” is commonly raised.
When evaluating how to best utilize profits at the end of your dairy business’s fiscal year, there are several areas to consider. Whether preparing for the next low milk price cycle, planning your dairy’s succeeding business strategy, forecasting tax liability outcomes or simply positioning your dairy for future success, you need to plan out how to manage excess cash. Below are best practices to reflect upon when your dairy operation observes a profitable year:
- Pay All Current Invoices: Assure that all current invoices and bills to your vendors are all paid in full and kept current. Not only is this good business practice, it also provides regular income to those organizations with which your dairy does business. It allows them to continue providing the services and products your dairy operation depends on. Accounts payable to vendors can also have higher interest rates which may have an impact on total dollars owed and increased cash expenses.
- Pay Down Lines of Credit: After you’ve paid all bills and your desk is clear of all invoices, look to your lines of credit, especially any operating lines of credit. Accelerating paydown of lines of credit will limit the amount of interest paid on the loan balances and will provide working capital if and when needed. Having ample availability on lines of credit can prepare your business on several fronts: 1.) having funds available if cash flow becomes tight; 2.) having funds available to pay for large transactions that cash flow may not be able to support, like hired custom work and crop input expenses; 3.) having funds available if you need prepaid expenses to help limit tax liabilities at year end, if cash on hand is not adequate to do so.
- Pre-Pay Business Expenses: When your lines of credit are paid down and you still have cash on hand, consider pre-paying business expenses for the next fiscal year. Expenses like seed, fertilizers and business supplies are common items to consider for prepayment. You can also account for these expenses when preparing your business’s taxes, which will ultimately limiting any tax liabilities. Furthermore, pre-paying may help with your dairy’s budgeting and business plan for the upcoming year, since these expenses have a fixed and known cost.
- Savings: “Putting money away for a rainy day” certainly holds true for any business. When you have paid your current liabilities and pre-paid your expenses, consider putting cash aside in a savings or money market account. These types of accounts are relatively liquid, allowing access to your funds on a regular basis. Not only will cash in savings provide added working capital, it can offer flexibility as consider future projects and planning. These funds can be applied as down payments to capital purchases, used to pay for the following year’s pre-pays and ultimately delivers flexibility with business planning.
- What About Capital Purchases?:“I have cash in the bank, should I buy my next piece of machinery with it?” Perhaps… Look very closely as you evaluate capital purchases out of cash flow. If you’ve accomplished everything on this list above and your business still has cash availability, you can consider applying it towards capital purchases. Ask yourself these questions when contemplating capital purchases using cash:
- Will the purchase deplete my cash on hand and is that my goal?
- Does the item being purchased provide an acceptable rate of return to the business?
- Can my business benefit from a tax perspective with the capital purchase?
- Is the item being purchased really needed on my operation?
When you have profits, establish a plan on how to best situate your dairy operation for a profitable following years. Every dairy operation is unique, with different ownership models, business plans and objectives. When taking the above areas into consideration, be sure to work with your professional team, such as your tax preparer, accountant, or lender to create a plan that is best suited for you and your dairy business. In due course, set your business up for future success by putting your profits to best use for your dairy business.
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