Section 6: Cow-Calf Cash Flow Enterprise Budget Analysis 101

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1 Section 6: Cow-Calf Cash Flow Enterprise Budget Analysis 101 Lets get started with some basics the Cow Calf Profit Equation The Cow Calf Profit Equation There is no single goal that will satisfy every beef producer, however, the following goal should be applicable to the cow-calf segment of the beef industry: Manage available resources for maximum continuing net profit (or minimize net losses) while improving and conserving resources. Lets consider this goal in the context of a simple profit equation for a cow-calf enterprise, stated as: Profit or loss = Revenue Expenses, or Profit = (price x production) cost of production Where price is a function of market forces, supply and demand; production is a function of forage resources, numbers and weights; and cost of production is a function of direct and indirect expenses and interest expense. In most cow-calf enterprises the manager has limited management control over the absolute level of beef cattle prices. Producing a desirable feeder calf and/or taking advantage of forward pricing and marketing alternatives as they arise, is a desirable management strategy. Market forces of supply and demand (market fundamentals) will determine absolute price levels. Beef cattle markets are currently experiencing fundamental supply and demand conditions that have led to record high cattle prices. Some market fundamentals to be familiar with include: US Cowherd inventory US calf crop Domestic and international demand Value of hides and offal Corn stocks Weather/drought conditions Technical indicators commodity futures market also impact current and future cash markets for cattle. You need not be an expert in beef cattle/commodity markets, but should be familiar with the current trends in both fundamental and technical indicators. There are numerous web sites that report market information, find one that works for you. Hear are a couple of links: The Livestock Marketing Information Center-- and Drovers Cattle Network

2 Production and the level of production is a variable in the profit equation that managers have some control over. Baring any wrecks, a manager s production decisions, together with the environment, will affect the number and weights of both weaned-calf production and non-calf production (culls). The ensuing drought should not be viewed as a wreck, at least not yet. Unfortunately, some range livestock producers in New Mexico have experienced a wreck in the form of wild fires. The lack of moisture and forage production has altered the environment; it is still up to the manager to use the best information and technology available to optimize production. Accurately defining and understanding the value of production and cost of production in the profit equation is essential to making informed production and marketing decisions to optimize profits or minimize losses. Integrating production and cost of production information from the profit equation can provide valuable information regarding unit cost of production. For example, consider our simplified profit equation. If the level of production and cost of production are know, then the profit equation can be set equal to zero, and we can solve for price or the unit cost of production necessary to breakeven. Price or Unit Cost of Prod. = (Total Cost/Production) If the objective of the manager is to decrease the unit cost of production, then it is mathematically apparent that management decisions must be made to: 1) decrease the numerator total cost; 2) increase the denominator production; or 3) a combination of both. Of course, another alternative would be to increase the price or value of production the current market is doing a pretty good job of that right now. However, trying to manage price without consideration of cost of production will not necessarily maximize profits. Keep this simple unit cost of production formula in mind; we will revisit it when we look at the enterprise budget. We know from past experience with drought, keeping the unit cost of production down is a fundamental goal of management. Ok, lets consider are simple profit formula on a per cow basis: Profit or loss = (((%calf crop x weaning wt.) x price) + ((%cull lvstk sales x wt.) x price))- expenses/cow For example, assume we have an 88% weaned calf crop (CC), as a percent of cows and heifers exposed to breeding, 500-lb average (WW), and a $1.45/lb. average price (PCC). Cull livestock, cows and bulls, were 14% (CL), as a percent of total breeding livestock, 1150-lb average wt. (CW), and a $.65/lb. average price (PCL). Total annual expenses were $525 per cow (ACE). Lets plug in some numbers into the profit formula. Example: Profit or loss = (((%cc 88% x WW 500lbs) x PCC $1.45/lb.) + ((CL 14% x CW 1150lb) x PCL $.65/lb.) ACE $525 = ((440lbs x $1.45/lb.) + (161lbs x $.65/lb.) - $525

3 = ($638 + $104.65) - $525 =$ $525 = $217.65/cow The profit example above provides a partial analysis of profit for our cow-calf enterprise example and is not intended to be a Generally Accepted Accounting Principals (GAP) financial report. However, the simple cow-calf profit analysis can provide some valuable insight for evaluating the what if production and financial impacts of a drought management strategy. Consider what the profit analysis example is telling us. The first thing we can note is that all values are converted to a common unit of measure, value per cow. This is important for establishing and monitoring production and financial goals and objectives associated with your drought management strategy. For example, in a normal year, we expect our average weaning weight to be 500lbs per calf, taking into consideration a %calf crop of 88%, results in 440lbs of weaned calf per cow for an average value of $ per cow, assuming an average market value of $1.45/lb. That represents a 60lb difference between average weaning weight per calf and production per cow, in a normal year. Our profit example also tells us that we produced 161 lbs. of cull livestock sales per cow for an average value of $ per cow or 14% of total revenues. Clearly cull livestock sales are important and are also a function of range carrying capacity and the reproductive efficiency or turnover of the cowherd. The level of culling will vary from year to year in most cowherds. Sustained high level of culling (16%+) tend to put a strain on cash flows as replacement livestock are retained and developed and/or purchased to maintain herd size. However, higher drought driven culling rates will increase cash flow in the short run and in today favorable cattle market situation present a opportunity to save for a rainy day and or invest in your drought management strategy. This brings me to the last observation I want to make about this cow-calf profit example. Most of us are most concerned about CASH FLOW. In our example, the net profit was $ per cow not bad. However, this does not necessarily represent net cash flow. In our example, if we retain replacement heifers at a rate of 15%, as a percent of exposed cows, this would reduce actual pounds of weaned calf marketed per cow from 440lbs to 365lbs (15% x 500lbs = 75lbs) or $ (75lbs x $1.45/lb.) of marketed weaned calf production per cow. The net cash flow effect would be a decrease of $108.90/per cow forgone cash receipts of retained heifers or ($ net profit/cow - $108.75/cow value of retained heifer). If we have 200 cows in our example herd, we would have a $21,780 cash profit to report to Uncle Sam AKA IRS Schedule F. My point to all the above, as you evaluate your drought management strategy, you must know and understand how the proposed strategy will possibly influence the level of production, the value of production, and the cost of production in your operation. The cow-calf profit formula provides a simple format for assessing the direction of profitability. Take some time to work

4 through several examples. Make some assumptions about level of calf production, value of production and cost of production, keeping in mind that many drought management decisions will impact the level and cost of production for several years out, spending a little more on feed supplements today may be a good investment for cow herd reproductive efficiency and next years calf crop. Early weaning may reduce calf market weights and revenue, but will likely also reduce the feed bill and improve cowherd reproductive performance for the coming year. Use the cow-calf profit formula in the NMSU Cow-Calf Enterprise Budget template (ref link to web site with template hear) to help narrow down your drought management alternatives, then use the cow-calf enterprise budget analysis provided in the same template to provide a more complete analysis of your top drought management strategies. Lets take a closer look at the cow-calf cash-flow enterprise budget analysis.

5 The Cow-Calf Cash Flow Enterprise Budget Analysis There are numerous beef cattle enterprise budget formats out there; in fact there are budget templates/analysis for almost any commodity you want to look at. The cow-calf enterprise budget analysis format presented here was developed with you in mind-the range beef cowcalf producer. A cow-calf enterprise budget is a management tool that can aid decision- making, much like the simple cow-calf profit formula previously discussed. In fact, the cow-calf enterprise budget is nothing more than an expanded/more detailed version of the profit formula. NOTE: It is important to keep in mind that the Cow-Calf Cash Flow Enterprise Budget Analysis is NOT a financial statement it is not a Income or Profit or Loss statements and it is not a Cash Flow or Statement of Cash Flow. These financial statement strictly coincide with your fiscal or financial reporting year, most cowherd production cycles overlap this fiscal year time frame. Therefore, when analyzing your drought management strategies, starting with the current year/actual enterprise budget analysis, production assumptions will be based on January 1, inventory or inventory of cows exposed in 2010, reflecting actual pregnancy rates (in fall of 2010 for spring calving) and calving percentages for current year. Cost and value of production (weights and prices) will be based on current fiscal/financial year and the market value of calf and cull production. This will provide an accurate enterprise cash flow for the current year. Drought management decisions will be made in the current year that will affect total costs and receipts for the year including increased feed and pasture cost and increased cowherd culling. Looking forward to next year, your projected cash-flow cow-calf enterprise analysis will be based on January 1, inventory or inventory of cows exposed in 2011, this year, recognizing that drought related management decisions made this year i.e. cow herd reduction and replacement rates, forage and feed availability/decisions will impact projected production and cost of production assumptions for 2012 and beyond. Hear in lies the value of the cow-calf enterprise analysis as a management tool to asses the probable impact of various drought management strategies. Simply put, for the purpose of cow-calf enterprise budget analysis, production assumptions reflect the reproductive cycle of the cowherd. Cost and value of production reflect current (or projected) financial/market year The Enterprise Budget presented here is relatively simple and consists of three sections: Herd Inventory Production Information and Assumptions Costs and Returns

6 The following discussion follows the format presented in the NMSU Cow-Calf Enterprise Budget excel template. (put link to template here) Cow Herd Inventory The first section of the cow-calf enterprise budget is the Herd Inventory. The herd inventory is necessary to calculate costs on a per unit basis--per exposed cow in this enterprise budget. In this enterprise budget analysis beef females are separated into three different classifications in the inventory. Mature cow - a female that is pregnant with at least her second calf. Replacement Heifers - a weaned heifer that has not conceived. First-calf heifers - a heifer that is pregnant or nursing her first calf but is not pregnant with a second calf. In Table 1, the inventory reflects the number of animals as of January 1 of the previous budget year, and or the number of mature cows (ex = 200 hd) and first calf heifers (ex = 25) that were exposed to breeding during the previous year breeding season total exposed females (ex = 225). The bulls in the Herd Inventory are separated into two major classifications breeding and growing. The breeding bulls are further separated for breeding mature cows, first calf heifer and replacement heifers. Depending on the size of the ranch, and the producers breeding program, producers may not run additional bulls to breed first calf heifers. Production information The Production Information section is separated into four parts (Table 2): 1. Mature cows 2. Replacement Heifers 3. First Calf Heifers 4. Bulls

7 The production information is a summary of pregnancy rates, calf crop percentages, number of calves weaned, weaning weights, culling percentage, replacement rate, and death loss percentage. Appendix Table A summarizes the assumptions used in calculating production values reported in Table 2. It is important to calculate these measures when completing an enterprise budget, all impact ranch income and expenditure. Cash Receipts and Costs for a cow-calf enterprise The first part of the costs and returns section deals with Cash Receipts from the sale, or projected sale of all market livestock calves and culls. Table 3 reports cash receipts by class of market livestock reported in Table 2, this information is transferred automatically in the Cow Calf Enterprise Budget excel template.

8 Begin the income section by completing the average weight per head (lbs) for cull market livestock. The enterprise budget assumes that cull market livestock weights will differ from the average of their class. You will also need to report the replacement rate for heifer calves, as a percent of the mature cowherd. If replacements are retained from first calf heifers, then you will also report the replacement rate for heifer calves retained as percent of the first calf heifer herd. Finally, you will need to report an actual or project market price ($/lb) for each class of market livestock. When calculating cash receipts, do not deduct any sales commission or other charges from the income; these values need to be reported with the direct costs. The total cash receipts per cow reflects the contribution each market class made to income from the sale of those cattle. Generally, the higher the numbers the better; however, large increases may reflect a high culling percentage. On the other hand, a reduction in these values may occur when a large number of replacement heifers are kept back into the herd. Given the same culling rate and replacement rate, increases in total pounds sold per cow reflect improved reproductive performance and growth. These items plus changes in the cattle market affect the gross receipts per cow. Appendix Table B reports the assumptions used in calculating cash receipts. Direct Cash Costs The second part of the costs and returns section is direct cash costs. There are several different direct cash cost items reported in Table 4. Reporting direct cash costs and other expenses

9 related to the cow-calf enterprise is often the most challenging step in the budget process. Depending on the producer record keeping system/chart of accounts, cost of production data can be difficult to summarize. Do not be discouraged. Begin completing this section by reporting the total of each direct cost item. At a minimum, most of these direct cost figures should be reported in your Schedule F and if necessary can be accurately estimated for the cow-calf enterprise. For example, the ranch may have both a crop and cow-calf enterprise, and fuel and oil and supplies cost for these enterprises are all lumped

10 together. Most producers can guesstimate the percentage of costs that should be allocated to the crop versus cattle, you will be surprised how accurate these guesstimates can be. Other direct cost items will clearly be cow-calf enterprise cost. It is better to estimate costs then not report any; you can always go back and make adjustments with the stroke of a few keys on the computer. The Excel template developed to support this enterprise analysis has an expanded direct cash cost section for; supplemental feed (see Table 5: Feed Rations); debt service (see Table 6: Annual Debt Service); and herd health (see Table 7: Herd Health Program). These are critical areas of beef cattle production that will likely be impacted by ones drought management strategy. Total values related to feed; debt service and herd health/vet med expenses can be directly reported under direct cash cost. However, Tables 5, 6 and 7 provide the opportunity to provide more detail related your drought management strategy and cash cost assumptions for these expense categories. Cash cost calculated in Tables 5, 6 and 7 are automatically transferred to Table 4: Direct Cash Cost. In our example, Table 5 reports supplemental alfalfa hay for yearling and first calf heifers and, grass hay and corn grain for cows, bulls, yearling heifers and first calf heifers. Table 5 simply allows for reporting feeding rate per day and number of days. Producers will need to determine the feeding rates based on the nutritional requirements of each class of livestock, considering current body condition, available forage and growth and or reproductive state of the animal. Table 5 also allows for reporting feeding rates for calves that might be early weaned as part of a drought management strategy. Note that pasture/grazing cost reported in Table 4 Direct Cash Cost if for leased pasture/land for livestock production, not the value of owned land. These pasture and grazing costs are calculated based on the number of AUM leased per cow or total AUM leased and the lease value per AUM. Table 6 allows for reporting actual or projected annual principal and interest payment associated with barrowed funds. Your drought management strategy might call for short-term barrowing to leverage additional feed/pasture resources. Table 6 is intended to help evaluate impact of debt servicing on cash flow. Keep in mind, the repayment of principal is not cost of

11 doing business, but is a cash outflow and is included as such in this cash flow enterprise analysis. Table 7 allows for a more detailed assessment of your herd health program. Drought conditions often increase herd health risk and needs. Drought related management decisions such as early weaning will call for a customized health program for these calves, and will result in additional costs, and benefits. Producers should work with their Veterinarian and review the literature for best practices for early weaning programs health, nutrition and management.

12 Total and Net Cash Flow To determine the total direct cash cost, sum the total of each direct cash cost item. To determine total cash outflow, add annual debt payments (principal and interest) to total direct cash cost. Net Cash Flow is simply Total Cash Receipts for sale of livestock less Total Cash Outflow. Net Cash Flow is the amount remaining to cover any non-cow calf enterprise cash commitments, including family living expenses, social security, Medicare and taxes. This Net Cash Flow figure does not report a Generally Accepted Accounting definition of profit, but does provide a pretty complete assessment of how a drought and related management decisions will likely impact the cow-enterprise cash flow as productions, cost of production and value of production variables change.