Defining Profit for Dairy Goat Herds!

Published on Mon, 03/20/2023 - 11:14am

Defining Profit for Dairy Goat Herds!

 By Dr. Larry Tranel, Dairy Field Specialist, ISU Extension and Outreach.

 Dairy goat producers need to be profit minded if trying to make a living or a secondary income from their dairy goat operation. Profit might not be just financial. Profit can also include “quality of life” features we might label “personal satisfaction” from non-financial gain possibly even at the expense of financial loss. Using budgets and financial analysis it is hoped that further exploration of financial profits can help lead dairy farms to higher quality of life profits as well. Budgets tend to be simpler, defining cash incomes and expenses, but should also include income or losses due to inventory changes (herd growth, depreciation, etc.) and unpaid cost like owner labor and equity use.

Profit is an orderly calculation of all farm incomes and expenses (cash and non-cash) to attain the Net Farm Income from Operations (NFIFO). This can be in a form of a budget that forecasts profits or it can be an “after-the fact” year end analysis. Profit is not to be confused with Cash Flow (all sources and uses of cash) as cash flow, Schedule F income, or even NFIFO can be misleading when used for profit analysis or farm or enterprise comparison. But, to do a profit analysis, one needs to first calculate NFIFO. This NFIFO can then be further allocated to unpaid resources, specifically the opportunity costs of unpaid labor and owner’s equity. From this profit analysis, many profit calculations, especially Return per Unpaid Labor Hour, Asset Turnover Ratio, Operating Profit Margin and Return on Assets can be attained to determine levels of profitability.

This table shares the basic items needed to calculate the Net Farm Income Statement to determine Net Farm Income from Operations. It is simply a calculation of Net CASH Farm Income (mostly available from Schedule F except breeding stock sales) that is adjusted for inventory changes using the End of Year Balance Sheet (Net Worth Statement) minus the Beginning of Year Balance Sheet.  This is necessary as a true profit picture includes feed, livestock and other inventory changes even though the transactions were not in cash.  The goal is to attain a NFIFO that is at least covering the Opportunity Cost of Owner’s Unpaid Labor and a Capital or Equity Charge. But, the NFIFO number needs further evaluation as, by itself, is not a very good indicator of farm profitability relative to many other measures.

In determining farm profitability, there are many ways to look at it.  First, a dairy goat farm would cover their full costs of production per hundredweight (cwt) of milk produced (including opportunity costs of owner’s unpaid labor and owned capital). Second, a dairy goat farm would earn a return to owner’s unpaid labor highly than can be earned elsewhere in the local labor market.  Third and maybe most important, a dairy goat farm would earn a Return on Assets (ROA) higher than can be earned in other financial markets and higher than the interest rate if money is borrowed.  If all three of these profit items are achieved, a farm would be considered profitable by any measure.  The reason the ROA may be most important is that it marries the Net Worth Statement and the Net Farm Income Statement and includes full labor costs so is an all-inclusive measure of profitability.  ROA is important as it is the basis of the profit equation in table below.

To increase profit, one can increase price received or reduce costs, thereby increasing their Operating Profit Margin (OPM) or their profit per dollar of income received. Or, with the same OPM, one can produce more volume or cwts thereby increasing their Asset Turnover Ratio (ATO). The ATO is depicted by how many years it takes to “gross” enough income to pay for all the assets on the farm. For example, an ATO of 25% grosses enough income to pay for all the assets in four years, 33% in three years, and 50% in two years.  So, the profit equation could read as ROA = OPM x ATO and every farm uses the profit equation differently.  For instance, low input grazing herds tend to have higher operating profit margins over time relative to higher producing conventional herds with some having operating profit margins in the 40% range or profiting forty cents on the dollar!  Meanwhile, conventional herds may be only profiting ten cents per cwt. or on every dollar of income received but have an ATO of close to 50% meaning they are grossing enough income to pay for all the assets in two years!  Both might receive the same ROA but earn it in different ways.

In the end, profits can be defined in many ways but ROA is an all-inclusive and most important measure determined from OPM and ATO.  NFIFO is a necessary beginning, but only a half-way point to determine true profits.  NFIFO minus and Owner’s Equity Charge (on assets not borrowed against) equals Return to Unpaid Labor.  It is advised to then divide this Return to Unpaid Labor by unpaid hours worked to determine a Return to Unpaid Labor Hour for easy comparison to available labor markets.  Again, the profit goals are 1) Full production costs per cwt lower than milk price received; 2) Return to Unpaid Labor per hour higher than what can be earned in the local labor market; and 3) an ROA higher than the interest rate being paid AND higher than what can be earned in the financial markets.  That would be a profitable dairy by any measure!

If all this sounds complicated, know that the Dairy Goat TRANS financial analysis program can assist in calculating and even benchmarking a dairy goat producer’s profitability. It will use a beginning and ending balance sheet to ascertain inventory changes which correlates to the Schedule F timeframe of income and expenses. Then, with additional information such as hundredweights of milk sold, unpaid labor hours and an owner’s equity charge, the Dairy Goat TRANS program will calculate a full profit analysis. In addition, many incomes and expense categories and financial ratios will be benchmarked for producer comparison to established goals.

Iowa State University Extension and Outreach also has a dairy goat budget that can be used for determining possible or potential profits for aspiring dairy goat producers. More information can be obtained from the ISU Extension Dairy Team or Larry Tranel