Financial Management Questions to Ask When Diversifying Your Dairy

With the current volatile dairy market, rising input costs, and continued challenges in commercial dairy production, dairy farm owners are looking for new ways to improve their profitability. If you're a dairy farmer interested in diversifying or vertically integrating your business, one option could be on-farm processing of raw milk into value-added goods and bottled fluid milk for sale. While this might seem like a fun, lucrative, and sustainable new venture at first glance, it's important to consider how you'll need to adjust and address your farm's business plan to accommodate for this change.

1. Management Team Support. It's no secret that there are many hands involved when it comes to dairy production. The owner, their family and friends, and employees seem the most direct, but there's also folks outside of the immediate farm that provide insight and support. People like bankers, lenders, accountants, financial advisors, crop advisors, veterinarians, nutritionists, milk cooperative leaders, and more. When diversifying into value-added production, that circle of support will grow even larger. Direct customers and wholesalers, product suppliers, inspectors, and more. Thinking about the people around you, your trusted advisors and helping hands, consider how your farm diversification will affect them and your relationship with them. Hopefully, this is a positive move for all involved. But, you may work with some who are hesitant, or have (oftentimes, very valid) concerns for this business venture. Without everyone on board and in the loop, there could be potentially disastrous consequences later on down the road. Bringing in third-party advisors, like Cornell Cooperative Extension Specialists or NY FarmNet Consultants, to moderate a management team discussion can be a helpful preventative step.
2. Business Life Cycle. Over time, businesses tend to follow a general lifecycle, pictured here. Farms are no exception and travel through a launch and start-up phase (as a new farm entirely or under new management/ownership through succession), to a period of growth, then a peak production of business maturity, and, finally, a decline to an exit phase (or transition to new ownership/management). Depending on where you, or your successors, are in the business cycle will affect any decisions you might make when diversifying your dairy. For example, if you're just getting started, do you want to add something new to your plate? If you're thinking about exiting the business, how will this new venture affect your retirement goals or transition to new ownership? Understanding where your business is, and what your future goals are for production, is an important consideration when considering a new venture.
3. Financial Position and Borrowing Capacity. You know the old adage "You Can't Manage What You Can't Measure"? This applies here as well, and having an accurate understanding of your farm's financial position is a key business planning consideration. You can work with your lender, financial advisor, or local Farm Business Management Specialist to perform a Financial Analysis of your farm business. While it might seem tedious, it'll give you a whole farm picture of your financial health by analyzing your balance sheet and income statement items. Do you know if your farm is profitable right now? If your farm is currently profitable, or has the potential to be, what would be the motivation to start a new venture? If you're not profitable right now, what would change if you added a new venture? While it won't come as a surprise to you, creating a milk processing facility on your farm requires a lot of cash. Consider your options for financing such a venture and the current borrowing capacity of the farm.
4. Cash Flow Budgeting and Profit Potential. For dairy producers, cash flow tends to be straightforward. Your milk is picked up regularly and you receive a check regularly throughout the entire year. However, a value added business will have an entirely different cash flow, depending on your market. If you're working with wholesale buyers, you might be fronting product that you won't receive a paycheck for right away. If you're going to be marketing directly to consumers, how will you handle the times of the year where customers might not be buying? Additionally, start-up costs associated with this new venture will impact the liquidity of your overall farm business, and limit your responsiveness to change. It's also important to have an idea of how long it will take for you to make a profit with this new venture as you balance start up highs and lows and customer recruitment to plan for cash availability.
5. Calculating Your Cost of Production. Do you know how much it will cost you to make and sell a gallon of milk? Tub of ice cream? Block of cheese? Calculating your cost of production by unit of sale can be a daunting process, but will be important to know what your breakeven price is and influence your business planning. An example - let's say you have an idea to make the most delicious, pint sized chocolate milks around. So, you listened to your friendly, neighborhood Farm Business Management Specialist and calculated what it would cost for you to make each of these pints of milk. This included the actual cost of producing the milk, the processing equipment and utilities, flavor ingredients, packaging, marketing, and more! You add all of those budgeted costs up, divide them by your anticipated production, and get to a cost of $12.30/pint of delicious chocolate milk as your cost of production. In this scenario, how long do you think it would take to be profitable at $12.30/pint? Or, would you ever be profitable, depending on your target consumer? Knowing your cost of production, or anticipating based on your enterprise budgets, will help you make decisions about how to move forward.
6. Opportunity Cost. Now, this consideration is one of the ones that gets me the most eye rolls, but from a "let's operate our farm as a business" perspective, makes a lot of sense. Opportunity cost is "the loss of potential gain from other alternatives when one alternative is chosen". Consider how much time and money and management effort will be involved in starting up a new value-added venture. What would your return on investment be if you used that money someplace else? This could look like improving your current farming operation, diversifying into a different venture, or even investing it via traditional routes. One example where I see this occur is, especially, with time. If the time you're spending growing and developing your plan was spent on, for example, improving your herd health - what would happen? Another consideration is how your current farming operation will change if you're spending time and effort on a new project - do you have a plan in place to keep things running smoothly if you're elsewhere? If you consider alternatives, and Value-Added Dairy still has the biggest returns, great. If it doesn't, how will this play into your business planning?
7. Wellbeing. One final Business Planning consideration I would urge you to evaluate is how this new venture will affect the wellbeing of your farm, your family, and yourself. This will change over time and vary by situation, but, in general, any new venture will cause a lot of stress and could negatively impact your wellbeing. Having a support system in place and a "plan" for how to handle things when the going gets tough can make all of the difference during those low times. Additionally, knowing how value-added production will bring you closer to your overall goals, your "why", will help motivate and safeguard your wellbeing which should be of upmost importance.

On-Farm Dairy Processing can provide a much needed lifeline for navigating volatile milk price swings, working through cooperative buying restraints, and providing new profitability streams to expand on-farm management and bring in new family members. However, this isn't a venture that should be entered into lightly and will have long-lasting impacts on your farm business plan.

This article was prepared by Katelyn Walley-Stoll, Farm Business Management Specialist with Cornell Cooperative Extension's Southwest New York Dairy, Livestock, and Field Crops Program as part of a "Diversifying Your Dairy" educational series. Katelyn can be reached by calling 716-640-0522 or emailing kaw249@cornell.edu. This material is based upon work supported by USDA/NIFA under Award Number 2021-70027-34693.