Agriculture is inherently a risky business. Farmers face various kinds of risks including weather, financial, human resource, marketing and legal risks. When farms are offered opportunities to mitigate risks, they need to consider how much their operations are exposed to certain risks and then take action to reduce or eliminate risks.
Weather risk is constant and there are some ways that dairy farmers can manage weather risks depending on the crops they grow and the methods they use. For instance, a dairy farmer in the Northeast can tailor corn varieties to mature within an appropriate range for our shorter growing season so that they can then plant a cover crop to improve soil health to mitigate climate change. They can also purchase crop insurance if they depend heavily on a certain crop to provide feed for their cows. Most farmers harvest their own crops and manage fertility to make the best forage for their herd. Having more control over a crop mitigates risk in crop production. USDA promotes crop insurance as a risk management tool for high-risk crops or crops that the farmer’s profitability depends on and policies are widely available. The decision to purchase crop insurance depends on perceived risk and a farmer’s ability to either manage risk or transfer that risk to an insurance company.
Financial risk can come in many forms such as interest rate risk, credit rating risk, cash flow and debt level risks. Banks use risk profiles to rate farmers asking for loans. Currently, banks are looking very closely at liquidity, working capital and break-even milk prices in order to make loans (or not) to farmers. Debt/cow is one measure that is easy to calculate by taking total debt and dividing it by the number of cows in the herd. Low debt is under $3,000/cow and high debt is over $5,000/cow. Banks offer interest rates based on the perceived risk to the bank that a borrower will default. Having lower debt/cow mitigates interest rate risk and the increases the ability to borrow money.
Another measure in the risk profile is liquidity defined as the ability to cover current liabilities with current assets. An example of a positive liquidity is being able to cover monthly expenses with monthly revenue. If there is enough income coming in the bank looks at this as a lower risk profile loan and will be able to offer a favorable interest rate.
Break-even milk price is another measure that banks may use to determine if a dairy farmer is a good risk and eligible for a loan. If a farmer can produce milk with a low break-even cost of $17.00/cwt then the farmer may be a good credit risk. If the break-even is $19.00/cwt the bank may not be as interested in lending funds due to the “tight” nature of the finances.
Consider the current environment of low milk prices due to the “Black Swan” event dairy farmers face today with Covid-19 that has disrupted the processing and marketing of perishable dairy products. The risk management tools that have been made available to dairy farmers include the Margin Protection Program (MPP) and the Dairy Revenue Program. Participation in MPP in 2019 was very good locally since the program started late and producers already knew that they would receive more payments than premium and it was obvious that there would be a payout. Some dairy farmers decided that signing up for 5 years at a discount would mitigate their risk by managing the margin between the feed price and milk price at a cost of $.12/cwt. These farmers truly understood the concept that MPP is insurance against the unexpected and a “once and done” approach meant that they didn’t have to think about MPP again for 5 years. MPP is subsidized and does not reflect the true cost of margin protection if it was purchased on the open market. In the past 15 years, milk prices have been volatile for a number of reasons and MPP is insurance against losing the margin of profitability on farms that can insure up to 5 million pounds of milk annually.
If your farm is not currently participating in MPP, there will be an option to enroll this fall with USDA FSA. This is your opportunity to minimize regret and maximize your margin at the $9.50 level. It will also reduce stress knowing that you have made risk management an essential part of your dairy business.