Managing Dairy Production Costs and Ratios

We have a number of terms and numbers thrown at us, especially in financially distressed times like now.  Milk/feed ratio, income over feed cost, breakeven, variable costs, and fixed costs, are a few terms floating around.  What do they mean, how do I figure out my numbers, and then what do I do with them?  To compute these numbers for your own farm, it requires a good set of farm records.

Milk/feed ratio, used mostly as an indicator of the current profitability of the dairy operation, is a standard formula of corn, soybean meal, and alfalfa hay the USDA calculates monthly.  When the milk/feed ratio is low (generally considered at less than 2.5), profitability is limited and the culling rate increases.  When the ratio is high (over 3.0), profits are enhanced.  The milk/feed ratio was 3.19 September 2007 and 1.44 February 2009.

Breakeven is straightforward, just calculate all the expenses on a dairy farm at a given production level and what milk price will meet those expenses.  If a farm changes its milk production level or its expenses, that changes the breakeven price.  Breakeven is a constantly moving target, especially with current commodity volatility.  Over time, any business's gross income must average higher than its own breakeven, or eventually it will not be in business.  Most current "Breakeven Milk Prices" report between $14 and $16 per cwt; however, many outliers exist.

Fixed costs are the expenses you have regardless of present milk production levels or herd size variation.  The largest fixed costs usually are medium and long-term bank payments, leases, rents, real estate taxes, and insurance.  Inappropriately structured fixed assets payment plans usually have long-term negative consequences.  On the other hand, keeping fixed expenses to a minimum may be a great long-term survival technique.

Variable costs are costs that vary in proportion to changes in some activity such as milk production.  If we decrease our herd size, the decreased feed and labor used to support those animals is variable cost.  If we can reduce feed cost, it is a direct savings of variable costs.  Feed expense is the largest variable cost on a dairy farm.  Labor, electricity, and supplies are some other variable costs.

Since feed cost is the largest variable cost on dairy farms, the industry has adopted Income Over Feed Cost (IOFC) as one of the standards to measure profitability.  IOFC is the balance left after all feed expenses are paid.   The challenge in calculating your own IOFC is that the cost of growing, harvesting, and storing forages (which includes land and machinery) is part of feed cost.  Current lactation feed costs range from $4 to $6 per cow per day; once again, outliers occur.  It may be tempting to lower feed cost by reducing or eliminating certain ingredients.  However, the consequences are that you will frequently lose more milk income than feed expense saved and, elimination of some ingredients could lead to long-term negative health problems.

Knowing what milk production level is needed to cover a cow's feed cost is important.  Let us call this Income Equals Feed Cost (IEFC).  To arrive at IEFC, take your daily feed cost per cow and divide it by the income per pound of milk sold.  For example, in September 2007, if feed cost was $7 per cow per day, and if you received $22 per cwt for milk, your cows only needed to produce 32 pounds of milk to pay for their feed.  In February 2009, if feed cost was $5.50 per cow per day, and you received $11 per cwt for milk, your cows needed to produce 50 pounds of milk to pay for their feed.  The IEFC helps the dairy manager make crucial decisions in any economic environment, such as deciding when to ship cows on the cull list.  In times when you operate below breakeven, you must attempt to have as much income above your IEFC as possible.  A concept similar to IEFC looks only at purchased feed cost instead of all feed costs.

Managing costs is always a challenge but hits us especially hard during times of low milk prices.  Adding cow numbers without adding fixed costs will lower the fixed cost per cow but may increase variable costs such as labor.  Improving the efficiency of the milking facility may lower variable costs but raises fixed costs.  Efficient high production has always been a driver in the dairy industry.  Keeping feed costs in line with our production and keeping fixed costs and other variable costs from getting out of control, are keys to good financial management.  It is important to make good decisions based on sound information whatever the economic conditions.  Tight economic times force us to scrutinize all of our management practices and in the end, we emerge a better manager when the economy improves.