Protect your business in difficult economic times

Earlier this year a big milk buyer collapsed leaving hundreds of dairy farmers adrift. Just how secure are your buyers – or suppliers – in a global recession? Ahead of next month’s Dairy Event & Livestock Show, Andrew Thompson, senior consultant at Promar International, offers some pointers on staying safe in business.

The global credit crisis, followed by the demise of a big farmer-owned milk processor, has led to the matter of managing risk moving further up dairy farmers’ agendas.

Most successful businesses appreciate that cash-flow is a critical factor and guaranteeing payments from milk sales is more important than anything else for dairy farmers.

More farmers will need to look at the security of who they are selling their milk to, which may now account for more than 90% of their total income. With the average monthly milk cheque being worth about £20,000, incremental cost savings being made elsewhere pale into insignificance with the loss of this income.

How is your milk buyer doing?

Gaining access to annual accounts of companies’ trading performance is something which other, non-agricultural businesses routinely do to help manage cash risk. Ultimately, one would expect to see similar patterns that you would look for in your own business, with the profit being sufficient to cover the demands on it, and the business being worth more at the end of the year than it was at the start.

For the larger, private milk buyers these patterns and forecasts can be tracked on the internet with trading statements published at least twice a year, and limited companies needing to make an annual return to Companies House, which can be accessed for a small fee.

Understanding the end use of milk continues to be important within this process. For the past 10 years we have tried to increase the transparency of market demand for milk. Increasingly, the global pricing of dairy commodities can be tracked directly to average farm gate milk prices, and producers must be clear as to where their milk is being marketed.

Where is your milk going?

Those on liquid milk contracts continue to see premiums being paid over those on lower-value, skimmed milk powder and cheese contracts, albeit at a lower price than two years ago. The firming of global commodity products in the past month may show some light at the end of the tunnel, with spot milk in New Zealand and Northern Ireland firming by more than 20%. Those reviewing their milk buyers should do so for the correct long-term reasons and make sure that they can extract the best value from each of their individual contracts. In particular we see milk quality issues on a number of new farms which we have recently started work with, often using inputs which are not generating cost-effective results. A lot of these areas are basics which get lost in the mêlée of running some very substantial businesses. An approach of “back to basics” often helps to manage risk, by simplifying systems and reducing the level of inputs needed, reducing the cash demands on that business.

One can argue that if suppliers go into receivership, then this may have a lesser impact on dairy farmers. But with straights perhaps bought forward at competitive prices, and specific products developed for individual farmer circumstances, then this process also needs managing carefully. Increasingly, p/litre payment systems are being used when reviewing buying. The ability to incentivise suppliers to work in partnership with the dairy farm focuses effort and helps both parties to win if the business generates better performance and profit.

In addition to this, the use of contract farming agreements, share farming and bonus or incentive schemes with herd managers helps to reward success when the farm makes better profits, with some of the pain of reduced profitability being shared when times are more challenging.

Managing volatility

Although the completion of budgets and cash-flows is difficult with volatile input and output prices, they do help highlight businesses growing, and help to identify weaknesses in those businesses struggling. At the same time it may help to prioritise where dairy farmers’ efforts should be focused to make savings. Effective budgets include at least five sensitivities, relating to market and customer or supplier risk. These help in this targeting process. For example, a farmer worried about a cost of less than £100 may be oblivious to the fact his feed price is not fixed and exposed to price shifts of more than £40/t, potentially costing him more than £10,000.

The banks have been largely supportive of farming businesses in the past 12 months, although the access and cost of credit has obviously had pressure applied to it. In most cases they don’t want uncommunicated shocks and surprises, and will work to try to provide short- and medium-term solutions. With base rate remaining at 0.5% for nearly 12 months, farmers have seen some significant cost savings in interest.

Although market volatility brings greater financial risk, there is still a great chance for efficient dairy farmers. These farmers continue to consider risk on a regular basis and are prepared to do things differently in the future.