Knowing your peak overdraft and principal repayment potential is key.
The DairyNZ business team completed two cashflow forecasts based on a 10-year average milk price of $6.67/kgMS and a conservative $6.00/kgMS milk price for the 2020/21 season. Both scenarios will require an estimated peak overdraft of -$82,000.
Scenario a) $6.00/kgMS - a cash surplus of only $28,000 limits the ability to repay principal.
Scenario b) $6.67/kgMS - there is the potential to pay $176,000 of principal.
These scenarios are based on the following assumptions:
- Farm working expenses $4.30/kgMS
- Interest rate on term debt 4.5%
- Drawings $100,000
- Capital expenditure $70,000
- Retrospective payments based on the 2019 milk price
- An opening bank balance on June 1st of $0
- $3.80/kgMS initial advance payment
Complete a cashflow forecast and communicate
No business is average, so it is essential to complete a monthly cashflow forecast for next season and discuss this with your bank.
There will be situations where farmer and banker expectations may not align so it is crucial to get on the same page as soon as possible before next season starts. A cashflow forecast is the place to begin.
Bank balance at 1 June 2020
There is an increased expectation from banks for farmers to pay off more principal. In most cases loans will have a term of 20 years and for an average farm that equates to $120,000 of principal paid per year.
Significant improvements to profitability will be required at a $6.00/kgMS milk price to enable debt reduction, however at a $6.67/kgMS milk price the required debt reduction is possible.
It is important to estimate what your opening balance will be as at 1 June, as this will affect your peak overdraft requirements.
Source: DairyNZ Business Team, Dairy Statistics, DairyBase data
NB: $6.67 milk price is based on farmgate milk prices from 2010 to 2019-20 in real 2020 dollars.
Milk price and farm working expenses
Ideally, farm working expenses should not be correlated to milk price. They should be optimally set with very little 'fat in the system' however, in practice we know in many cases costs can be trimmed with minimal impact on revenue. Our estimates, based on Graph 2, are that Farm Working Expenses will be approximately $4.30/kgMS for 2020/21 season at a milk price range of $6.00 to $7.00/kgMS.
Milk price impact on cost areas
Graph 3 shows the three cost areas that farmers have historically changed when milk price changes. These are:
- maintenance and vehicle running costs
Develop a farm management plan now based on the two milk price scenarios ($6/kgMS and $6.67/kgMS).
Identify cost areas you can trim and still stay in business. What feed costs do you consider to be only marginally profitable? Can you defer maintenance without significantly impacting the smooth running of the farm? Can you cut fertiliser by applying it more strategically? As well as these three big expenses analyse all the other costs. Which costs have crept into your business and you are not quite sure why? This might be the season to take them back out.
Successful farm businesses
It is impossible to accurately forecast milk price, however we know the most successful farm businesses always have two to three plans in their back pocket. Get your plans in place now and be ready. Ask yourself: how can our business survive at a $5.00/kgMS milk price and can we thrive at $6.00/kgMS and $7.00/kgMS?
If you need support to develop your financial plan and cashflow forecast for next season there are number of options:
- DairyNZ’s budget templates and videos will help get you started https://www.dairynz.co.nz/business/budgeting/budgeting-tools/
- Dairy Training Limited’s excellent budgeting course Business by the Numbers https://www.dairytraining.co.nz/courses/business-by-the-numbers/
- Farm consultant can help you develop a budget so contact one now https://www.nzipim.co.nz/
- Dairy Connect links farmers with support farmers on specific topics needing advice https://www.dairynz.co.nz/business/dairy-connect/
- Rural Support Trust is there if you have really ‘hit the wall’ and need to talk about where to next http://www.rural-support.org.nz/
- DairyNZ Consulting Officer, as always, can provide advice and direction https://www.dairynz.co.nz/contact-us/regional-teams/