University Place

Dr. Bernhardt maintains a split appointment that's 50% farm and risk management specialist with UW-Extension and 50% director of the Pioneer Academic Center for Community Engagement at UW-Platteville. Extension efforts include applied research in developing and disseminating curriculum materials and decision tools in the areas of farm, financial management, risk management, and commodity marketing. Dr. Bernhardt-- Dr. Bernhardt also teaches various agribusiness courses in the UW-Platteville School of Agriculture. And his related experiences include stints with Economics department at the University of Nebraska in Lincoln, the US Department of Agriculture, and the Hills Bank and Trust Company. So please join me in welcoming Dr. Bernhardt, and get ready to buckle up for the ride.

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Thank you.

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I have to start with an apology for my voice. I'm one of the-- However many residents of Wisconsin there are, I'm one of all but 10 that have had a cold or the flu in the last couple of weeks. So my voice is a little bit low. My wife kind of likes that because she says I growl a little bit better to my kids.

laughter

Although, I haven't seen any much reaction from them that's helpful, so I guess it doesn't make much difference there either. I also want to acknowledge a couple of students in my class that are here. They had the misfortune of having me last night for three hours in one sitting. And here they are again. So they wondered if they could get extra credit, and I'm beginning to wonder that maybe that's probably a good idea if they're going to sit through another hour of this. Our topic this morning or this afternoon is

Buckle Up

How to Prepare for the Bumpy Ride Ahead. Really talking about the cyclical nature of business in general and the cyclical nature of agriculture as well. So that's what we're going to look at. And the first part-- Well, let me get to the next slide here. Our agenda for the next hour is in three parts. You know, the first part is a view from 10,000 feet. So, let's take a view of the agricultural economy. Let's take a view of the general economy, especially how it may add or be a part of the cyclical nature of business and the cyclical nature of agriculture. And we'll use that then as a transition into looking at cycles. Looking at the cycle of Ag and the cycle of the general economy. How the two might come together. Where we're at today. Where we're at today on that. And then, the last part, this will be about the first half hour. The last half hour is, "Okay, so what?" You know? That's nice. That's nice to hear. And if you're in my class and have to take a test, you know, you have to listen to that stuff. But that's not where most of you are. Most of you are back at the farm and you want to know how does this affect me at the farm gate. What can I do with this information back in my farm business? And so I'd like to take a stab at perhaps some things to think about. Hopefully, you'll be able to walk home with something of value after you leave this part of your conference today. All right, view from 10,000 feet. Well, that's actually not 10,000 feet. That's actually 238,000 miles or one billion feet, but we'll get the idea. We're going to take a look back. Profitability. The next couple of slides I'm going to show you is where net farm income has been, where it's been trending, what can we say about it most recently.

And here's the end of the story

income trends have been up. Both in real terms, which takes inflation into account, and nominal. Now, that doesn't mean your income has been up. Income in general, on average across the United States for agriculture, has been up. Trending up. The variability, however, is also up. And you've lived with the volatility of prices. The volatility of income is also growing. The recent past, in particular the last decade, has been particularly strong, particularly for grains. For grain farms. Not so much for dairy, but particularly for grain farms. But the very recent past, as in this past 12 months, we're seeing a very different story. Now at noon time, after a great lunch was over, I looked up the markets and December corn $3.77, November soybeans $8.89, live cattle $1.36, feeder cattle $1.58, and Class III prices for milk ranged from $13.50 in the nearby months up to $15 later on. In which one of those can you make money? -

audience is inaudible

And here's the end of the story

None of them, for the most part. Now, some of you can, and we're going to see some of that. Some people have been able to make money in those low price times too, or at least in a break even way until things get better. But right now, things are challenging. We are definitely at the low part of that cycle. Well, here is US nominal net farm income, and, as you can see from this picture, the recent past going back to-- What is this? This is about 1980 when we had the last farm crisis time. We had a very different structure of Ag that came out of that, and we have been increasing trends in net farm income ever since. But you also notice that the volatility increases as well. The highs and the lows are further apart. And that can be sometimes tough to live with. I can't remember how many times my dad, who's now 96 years old, said to me, you know, I wish prices would just stay at blah, blah, blah, blah, whatever it was at his time, instead of this. And he was talking about this as in the 1950s, 1960s. Today, you know, that's like this. And that can be hard to live with. In the last decade, this goes back, you can see where the 2003 year is. In the last decade, we've had particularly high net farm incomes. And if we want to look at this in real terms, "real terms" meaning that we've taken inflation into account. So this is actually a measure of wealth not just the price itself. There's the nominal one, and here's the real terms. So you can see on this that we've had some really high times of wealth. This was back in the 1945. This was right around 1973. And here's right around 2002 to 2004. But this is where we're at today. So that's where we're at; Compare that to the bottoms. Pretty darn close, isn't it? This is the forecast. The USDA does this thing called "baseline," baseline forecast where they'll forecast out 10 years. The green part at the very end is what they have as a forecast for prices. This was based, I think, in December of 2015. So not too long ago. And that's in real terms. That doesn't paint a very rosy picture, does it? All right, let's talk about debt. There's one good piece of news as we go into this low price, low income time era here. And that is that the balance sheets for agriculture generally are pretty darn strong. That's something that's very different than the 1980s, by the way. There's a lot of people who've wanted to compare where are we heading right now, how does that compare to the 1980s time. There are a few people around the room here who may have been in farming back then or close to it and remember that. It wasn't a very fun time period. Not very fun at all. But the one thing that's very different is we have strong balance sheets right now. Again, maybe that's not your farm, but in general we've had some good income in the past decade and we've been able to pay down a lot of debt and we have good balance sheets. So, total debt is up, by the way, but total assets are up by a lot more. So the combination of the two, the debt to asset ratio is a measure of how leveraged we are. That's in a good, healthy place. And you'll see some graphics on that here in just a bit. A question I'll take just a little bit of time with, I love taking a lot of time with this if we could, but we can't today,

but that is the question

is debt a danger or a friend? You know, what's the scoop with debt? Is it a bad thing or not? We'll talk about that just briefly here. Total US farm debt, you can see it's up. And here's where we are today. That's getting very close to where we were back in the 1980s. So that kind of sends up some red flags when you see that. But this is that same debt line way down here. Here's assets. So, assets are way higher than what they were back in that 1980 period. And so when you put the two together-- Oh, by the way, a lot of that is on real estate debt. A lot of that asset value is on real estate debt. So what happens if the real estate has a bubble that bursts, so to speak? That really can bring those asset values down. That's something to be a red flag for us. But when we put it together, we have this nice, long trend of the debt-to-asset ratio falling, meaning we have good, much, much better positions with respect to debt. The debt to asset ratio-- For every dollar of assets, how much debt do you have? You want that number to be lower, if possible. So it's been trending down. However, look at the very last little part of that slide way to the right side. What do you see? It's starting to turn back up. That's a reflection of the income challenges that we've had in the past year. Now, what's the relationship between debt and profitability? So, the return on assets is the blue, dark blue line in there. The return on assets is a measure of profitability. How does that correlate with the debt to asset ratio? With how much debt we have? And if you look at the screen carefully, they're going just opposite in most years. Not always, but most of the time they're traveling just opposite of each other. So that would lead one to believe that the higher the debt I have, the lower the income I'm going to have. That would lead one to believe that conclusion certainly looks like it. Got to be a little careful there. You always want to be careful when you're looking at averages because averages can be big time liars. So we want to look at that maybe a little bit deeper. Here's a range of return on assets. Let's look at the profitability side of this for just a second, and then I'll bring the debt back in. So there's the average return on assets, average measure of profitability over the course of what? 1996 through 2014. There is the lowest 20% farms. This is what their return on assets, their profitability, has been. There's the middle set of farms, which follows right along the average which you'd expect. And the top 20% of profitable farms are way up there. So my point being there is that there's quite a range. Same type of farms. All of these are from the FINBIN database out of Minnesota. So most of them are from Minnesota, Iowa, Wisconsin, Midwest area. 10% range. That's a huge range of profitability. Now, how does that correlate back? Let's bring the debt back into this. These two bars, the one on the left is low debt farms. These are farms who have low debt, and the measure on the vertical axis is income. And the bar on the right side is high debt farms. So, again, I look at this and I'm kind of led to conclude, well, the lower the debt I have, the higher my income. And, on average, that's what the data shows. But let's look at it a little bit closer. Those two gray bars you see are the same two gray bars from the previous slide. It's measuring the same things. Low debt farm on the left, high debt farm is on the right, and how much income they're getting. But now look, as I go through this, within that group of farms that have low debt, there's quite a range in the net farm income that they are getting. And you can see that range on both sides as we go through there. So, on average, the higher the debt you have, the lower you income. That seems to show itself on average, but don't be too scared away by that or don't be too happy by that, either way, because there's a lot of room for different kinds of farms to come in, different kinds of management to come in. Some farms make a lot of money with high debt. In fact, if you look at the most profitable farms-- I've looked at a couple different databases and checked this out. The highest profit farm, the ones way at the top, also have the highest debt. All right? The ones way at the bottom, the lowest ones in profitability, often have the highest debt. It's all in how you manage that debt that makes a difference. And this is really true, very useful when we think about the cyclical nature of Ag coming up. So here's the situation. We have a $100,000 of debt. We're paying 6% interest. On that on an annual basis, we're going to have to pay $6,000 of interest back to the bank. That's our cost of using that money. If we use that $100,000 to buy cows or tractors or land or whatever and put that asset, that capital asset to work and that capital asset returns 10% return on assets, 10% profitability, in other words $10,000, then the difference between those two numbers is $4,000. Positive. What happens to that $4,000? I get to put it in my pocket. It's mine. That's called the equity multiplier or the leverage position of debt. In this case, debt's a friend. I'll do this all day long. I'll do this all day long and keep on making more and more money myself by using your money to finance my operation. Here's the second situation, though, it works both ways. That same $100,000 debt, same 6% interest, but now I'm using that debt in ways that I'm only getting a 2% return, profitable return. Or, in other words, $2,000. Now it's $4,000 but it's negative. Where does that $4,000 come from? Well, there's not too many lenders I know that will say-- There's a lot of Badgerland lenders around here. Not too many of you will say, "It's okay, you know, we'll eat that this year." No. You're going to have to come up with that $4,000 from someplace else. So that takes away from your profits. That's when debt becomes the enemy, so to speak. So, debt is a tricky thing. It can be friend or it can be foe. The key there is that your return, your profits that you return from the use of that debt, you want that to be greater than what the interest rate is. All right, cycles are cyclical. Well that's-- I should have that as a test question. That'd be pretty easy, wouldn't it? All right, here's a long-term database going back to-- I don't know if you can see it there, but this goes back to 1805. So a long, long time ago. What I find interesting here, each one of those bars at the top, the length of that bar is about 30 years. If you look down at the end points of each of bars you see you have kind of lined them up with different peaks. I don't know why. That I can't explain. I'm sure somebody can who's a lot smarter than I am. But it appears that about every 25-30 years or so something happens in our world, several of these have been wars and other kinds of things, but something seems to happen about every 30 years that makes commodity prices zoom through the roof. Kind of interesting. Well,

there's what you've seen already

our net farm income. And I just kind of look. You know, here's a peak; A small, little peak. Here's a little peak. Here's a little peak over here, etc. And look, 29 years apart, 25 years apart, 31 years apart. Yep. Our Ag commodity prices tend to follow that same situation. You'll see another one with corn prices later on. If I look a little bit closer, that's the big cycle, if you will. But we also seem to cycle in a little shorter period. You know, there's six years apart between those two little peaks. And there's a whole bunch of other ones there. Eight, five, three. There's some that are smaller too. But if I kind of ignore those small, little variations and just concentrate on the ones on top, then we're looking about four to five years. Every four to five years we tend to peak up and then we go into another cycle in agriculture. Well, the last peak was right here. That was 2013. Take 2013 plus four or five years, what do you get? Our next peak for net farm income being in 2017-2018. You know? Now, you gotta be awfully careful. Awfully careful when you go and you start doing-- Nevertheless, I'm going to do it again a couple times before this presentation is over. But you gotta be awfully careful because about the time that you think you've got it figured out over the rest of the world and you invest because of that or you invest that way, what happens? Well, that's the time instead of four or five years, it's six years or it's two years and you get caught. So, I am going to talk about being countercyclical, but you also want to be measured and careful about that as well. All right, prices. This is a set of corn prices that go back to 1866. And something interesting here. Again, it's this 30-year deal. But what I want to-- Let me just bring them up here. These are all different time periods. And what's happened with each one is here's the average during this period of time, and then something happened to break prices out of that range. That something happened to be World War I back at that time. And then it kind of went into this new range, this new variability. The average price was higher than what it was before, but so was the variability, so was the volatility. Now we get back here, we have to have another war in World War II, 1940 to 1945, in that era. We break out again. We break out again, and we go into this new era. Higher average price but also a higher volatility as well. 1973 we break out again, and we go into this period now back here about 2004. We broke out again. So, how long will this last? These are all 25-30 years apart. Who knows? Those little orange dots at the end is future's prices as of a couple days ago. So, same situation. Milk price cycle. I concentrate on milk quite a bit in my work, and so I've always enjoyed this slide. This is going back to 1996 with monthly milk prices. Class III prices. Those red triangles show different peaks. There's other peaks in there, but these are some of the major peaks. And here's the number of months between each one. And it's about 35 months or about three years apart. And most of you who are in the dairy industry probably recognize this cyclical nature of milk prices. So, again, the last one was in September 2014. That's this one right here. So you take September 2014, you add 35 months, then we should hit our next peak in July 2017. So, again, completely disregard that when you leave this room because if any of you plan on that happening, of course, it won't happen that way, right? But the point is made, somewhere in there, you'll end up probably getting-- And you can see. You can look yourself and see that it's ranging from 27 months up to 48 months. So it's not an exact science. But there certainly is that cyclical nature to it, though. That's kind of the point. This one I love to show. This is also milk prices. And the gray line is milk prices from 1980 to 2003. The blue line is from 2004 on. I guess it went to 2015 in this case. The red line is the average during those two time periods. And the two black lines are the top 25th percentile price during that time period and the bottom 25th percentile price during that time period. So, you can look just visually and see how the range between top 25th and bottom 25th has grown significantly. And now you can see in the yellow box there that average has gone from $11, almost $12, to $16.25. Pretty big jump. Now, for giggles and grins one day, I took a 207-cow dairy-- I'm not sure why I picked 207. Must have been something I was doing at the time. I think I was looking at an actual one from the database. But 207-cow dairy happened to be milking 22,000 pounds. And I looked at the difference between the top 5th percentile price and the bottom 25th percentile price. Well, during that 1980 to 2003 period, that was a swing of $66,000, almost $67,000, of cash flow. Significant. But, in the more recent period, that's a $210,000 swing in cash flow. Same number of cows. Same production. Just the volatility of prices. That's what you're dealing with is that volatility. Yeah your average price is higher, but so is your volatility. All right, where are we at today? The next few slides are not Ag ones. They are from the general economy. This is an index that a lot of economists will look at called the Leading Economic Index. And where you see the arrows, you gotta look a little bit closely here. These gray bars you see during these time periods? These gray bars are going up and down. Those are time periods of recession. Of the general economy going into recession. And if you look where the red arrows are, the Leading Economic Index turns and starts going down about three to nine months before that recession begins. And it's almost like clockwork, you know. Every time you look back here, every one of these, most recent was in 2009, things started turning down about six to nine months, three to nine months ahead of time. That's why it's called Leading Economic Index. Well, if you look at where it is today-- There it is. You don't see much of a downturn. Looking at that only, the last data point here was January 2016. So, very recent. That would indicate that we are not headed for any kind of recession. At least not by looking strictly at the Leading Economic Index. Now, if you look at it really closely, right there, it is heading down, but that's not much of an indicator yet at this point. So, looking at that only? All right, let's keep on keeping on. But here's a couple other ways to look at it. This one is an interesting graph. It shows how far away percentage-wise the index is from the previous peak. In other words, it gets to that peak, that's when it's going to turn around and go into a recessionary area. We're 1.1% away from that at this point, and you can just tell by the graph we're getting awfully close to the time period when we hit this line that represents the previous peaks of that economic index. Another way to look at it, this is looking at the same thing. The green parts here are when we did not have recession; the red parts are when we had recession. Here's that 1.1% that we are away from hitting the divider between the two. The other thing I look at here is just how wide the green area is here. I compare that to the past. Yeah, kind of makes you think we're heading somewhere, doesn't it? China's GDP growth, don't want to spend a lot of time here. This is a comment from David Cole at the bottom. He's an economist out of Virginia. He works on his own now, but he's a good guy. He knows his stuff. And his comment was that if GDP growth from China goes below 3%, that's the flyover states of the United States, which is the Midwest, are going to have some serious, serious problems because China's not going to be able to afford to buy our commodities. We're at 6.8% as of January 2016. A long ways away from 3%, but you can see the direction. So, again, some cause for concern there. Here's the US dollar. It's high. The strength of the dollar is high compared to other currencies. That's not good for agriculture. The higher the dollar-- It's great if you're traveling. If you want to travel somewhere, you're going to be able to buy a lot more Euros and whatever else than what you were before. But if you're trying to sell corn, if you're trying to sell milk, if you're trying to sell soybeans, or whatever, it's not so good because it makes our stuff more expensive than other corn from other countries around the world. So that's not a good thing. Now, this goes back to 2006. Keep track of this red bar right here. You can see we're above the previous peaks. This goes a little bit longer. This goes back to 1983, and here's that same red bar that you saw in the previous slide. And you can see where we are today compared to some of the previous peaks in the past. And every time we peak in the US dollar, we tend to run into a recessionary time. So, again, maybe an indication there. Real quickly, spot oil price. That has a big deal with agricultural economy too. Our oil prices are down. Down significantly, which usually is associated with recessionary times as well. I'll just ask you, in general, put a number in mind, when do you think the next general recession is going to occur? 2016-2017? 2017-2018? 2018-2019? Pick a number. Pick a number. I'll ask you to raise your hand in just a second. Pick a number here quick. When you do you think the next recession will happen based on what you just saw? -

inaudible

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Think

when do you think it'll happen? All those who said five, recession in 2020 or later? You all should raise your hand because we probably will have a recession sometime after 2020, but we don't know when, right?

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Think

I cheated on that one. Number four, recession 2019-2020? A couple. Okay. Number three, recession in 2018-2019? All right. Recession in 2017-2018? Number two. More hands going up. Recession in 2016-2017? Yeah? So, next year. Next year is the vote here. In general, what do you believe might be the outlook for farm profitability in 2016? Forget the 2017 right now. For this year, which one would you vote? Heavy losses, some losses, break even, some profitability, major profitability. Those who said five? Those who said four? I love the optimism. Nice job. Those who said three? Those who said two? And one? Okay, yep. So, I think we feel that there may be some pressures in farm profitability. Which emotion describes you right now? Here is the cycle. You know, it starts low.

This is the down times

bad prices, bad profitability. This is euphoric times, etc. I'm going to snap some words up here. Which one describes your mood? Optimism? Excitement? Euphoric? Denial?

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This is the down times

Fear? Panic? Despondency? Depression? Back to hope and optimism. I won't ask you to raise your hands this time.

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This is the down times

But which one of these kind of strikes your mood? Now, you've been here in Madison in this great place with all your fellow women farm colleagues here the last couple days, so maybe it's a little bit more exciting today than it will be perhaps next week or next month when you go home. Well, all very nice. Nice little trip through a bunch of graphs and everything else. Now, what does it mean at the farm? What does it mean at the farm? And I'm going to present this to you in two ways. In the short run-- I think there's two elements here. If we are at the bottom of that cycle, then things are tough. We're not able to pay our bills very easily. We've got loans coming up that we may not have enough cash flow for. Worrying about being able to pay our interests. Certainly worried about having some profitability to do capital replacement and things like that. When we're at that time period, when we're in that low, not by anything we've done wrong by the way, it's by the way the economy cycles. Outside of your control. But there are some things in there that you might be able to prepare for or help you get through. But the name of the game is to get from this bottom part to the other side. Oh, I already got rid of the slide. Back to hope. We need to survive and get back to hope so we can start taking advantage when the price swing goes up. And cycles are such-- They are so emotional. When it comes to money and income, it's so emotional that when we're at the top, then we all convince ourselves it's this way forever. Right? Life is going to be this way forever. We're going to have $6.50 corn prices forever. We're going to have $21 milk forever. We've hit a new plateau. They finally recognized how worthy we are out here.

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This is the down times

Good luck. Yeah. Our emotion when we're at the bottom of that cycle is that we're never-- It's never going to get better. We just are-- The glass is half empty, and it's a very emotional response. We're never going to be able to come out of that. Both of those things are wrong. What's up is going to come down; what's down is going to come up. We don't know when. We have some indications, but we don't know when for sure. But the name of the game when we're down at the bottom is we got to cash flow. That's the short run. We got to figure out how to cash flow and pay our bills in the short run. In the long run, what I'm going to submit to you here today is we want to start building up our capacity for the next time the cycle goes down. So, we know it's going to go down. We know it's going to happen sometime. We don't know when, but we know it's going to happen. So let's build the resiliency of our business so when that next time comes, we're ready to go. And I got to move a little faster here. I'm talking too much. So, cash flow. Here's the different elements that create your cash flow. Those are the things where you have cash coming in. Cash inflow from the operations when you sell milk, when you sell corn. Capital asset sales, if you sell that tractor, if you sell a piece of land, if you sell a cow, you got cash coming in. Non-farm sources. Off-farm job, etc. These are the things that take away from your cash flow. Cash outflow from operations, feed, seed, fertilizer when you pay for that. When you buy that new tractor or buy that new cow. Non-farm outflows, family living being the big one. And when you make your debt payments. These are all things that take cash out of your pocket. And, of course, at the end, we can borrow new money. That brings cash in. So, if we want to increase cash flow to make it through this down time, one or multiples of these have to change. Have to change. So, let's look at these. Here's a warning, first of all. Here's the guy on the left who says, "I'm going to create some cash flow. I'm going to sell all my cows."

laughter

This is the down times

And the guy on the right, he looks like kind of a crotchety old guy, he looks over and says, "That's a dumb thing to do. "You'll have no milk to sell. I'm just not going to feed them." I'm going to save all that feed cost.

So the warning here is

In the midst of trying to increase your cash flow, make sure you don't throw the baby out with the bathwater. A lot of balancing has to take place here. So let's take a look at some of these. Increase cash inflow from operations. Greater production efficiency, better marketing. You might not be able to get a higher price, but at least you get a known price. You could sell inventory. Grain in storage, feeder cattle, etc. Remember, you're going to have tax consequences with that. That's the balancing act. Benefit cost for culling decisions. Can that cow still make you money? If so, keep her. If she can't, then maybe you can cull her and get some cash in that way. Some extra custom work that you could do. And maybe there's some wild things out there. Agritourism, boarding some horses, or storage for boats and campers. Some small things that might be able to create some cash flow, depending on where you live. Another thing you could do is sell your capital assets. Sell your tractor, sell your cows, sell some land. Those are ways to create cash flow. Now, the negative of that, the balancing part is, if you sell some cows, you do get some cash in right away, but you also forfeit any future cash that you would get from those cows. That's why they're called capital assets. You know? Land, the same thing. You could sell some land and get some good cash back, but then you don't have that land anymore for future revenue. So it's a balancing act there. Outsource activities and sell associated assets. Custom combining might be an example. Instead of having that combine yourself, sell it, get the cash in, hire somebody else to custom combine it for a few years until you can buy that combine back, if you want. Sell low profitability enterprises. Increase income from non-farm sources. Off-farm income, off-farm job. Sale of non-farm assets, if you have some. Is there a potential for some family contribution in the short-term to get you through the bottom of that cycle? Is there an investor partner that could come in in a limited way and provide some cash to your operation. You might have to get creative with some of those ways. Reduce cash outflow from operations. Reduce your variable costs. Is there ways you can do that? Cheaper ration ingredients, better feed management, variable rate application, reducing your labor costs. Labor is huge, especially on livestock and dairy farms. Reduce land costs. Maybe it's time to go talk to that landlord. Negotiate. Show them the prices. Negotiate those contracts. Collaboration. We used to do it a lot in agriculture. We still do, and maybe there's room for more. But bulk buying, shared fieldwork, etc. might be a way to increase your cash flow. I'm going to go over this pretty quickly. Dairy operation costs, one thing you want to look at is if you're going to reduce cost, go to those areas that have the highest amount of cost in your operation. If it's a dairy, purchased feed, hired labor, and asset replacement are the three biggest. If it's a grain operation, land rent, fertilizer, seed, asset replacement, repairs. Those are some of the bigger ones that affect your operating cost. You could also delay, reduce capital asset purchases. So, you're not going to sell a tractor, but you're not going to buy one either. So that's less money that's leaving your operation. What's the cost benefit of that versus having to repair that old tractor? That's a question you have to take up. You could also have a collaborative swap with neighbors for machinery, labor, and be able to delay perhaps a capital asset purchase. Reduce non-farm outflows. Family living comes in here. You can only reduce that so far. Maybe there's some things you can do in the short run. Is there some family bonus type things that are going on that you're paying for that really don't have much to do with the farm operation? Maybe it's time for a son or daughter who's back at the farm, they've been living free for the last 10 years, and maybe they need to pay their own room and board, at least through the down time. Reduce scheduled debt payments. Go to your lender, but be well prepared. Show your lender how you're going to come out the other side of the cycle with a good, strong plan for being profitable. Maybe you can negotiate a lower interest rate. Maybe you can have some principal write-off. It'd have to be extreme in that case. More likely, perhaps you can do some debt restructuring and get a longer amortization so you can lower the amount of cash outflow that's facing you today. Interest-only payment this year. Something like that. And, of course, there's always new borrowing. That's a possibility. That cash flow piece, a lot of different things there. Can you see in your operation ways that you could increase capital asset sales? Increase cash coming from operations? Reduce the cost? The following slides gave a few things, but that's not even hardly a scratch in the tip of the iceberg as to all the possibilities that are there for ways that might create that additional cash flow. Remember, this is short-term. You're just trying to get through. You're trying to get through that cycle, what? It was four or five years we saw for net farm income? The down part of that is one, two years. That's what you're trying to get through. Until you can get to that upside. The second part of this is what I think is more exciting. Let's assume. Let's zoom ahead a couple years. We're out of that trough and we got some hope and optimism coming back up the other side. Now we have some flexibility to do things where prices are coming up, whatever. We're finding we got some more income coming in. Can we think about building resiliency for our business before the next down part of the cycle? And it's not just for being able to address the next down cycle. It's also to increase our profitability overall. Increase our ability to transition to the next generation. I see a lot of young folks in here that I'm sure would love to go back to the farm. Can we figure out better profitability on our farms so we can bring them back into that farm? So, the way I'm thinking about this is building resiliency. Now, here's the image. The wheel. You saw on the last slide, I had my caveman there. You know, with the wheel, that's the start of it. The wheel. Here's different areas that we want to have strong management in, in order to be able to build resiliency of our business. In order to be able to shore up all the spots where we could have leakage. One of those is human resources. I got to look at the screen. One of those is strategic planning. One of those is risk management. Profitability. Good records. Marketing. Financial planning. Efficient production. You could take yours and you can put different combinations in here, right? But the idea of the wheel is the resiliency of our business is only as good as how nice and big and round that wheel is. What turns easier, a small wheel or a big wheel? A big wheel. Right? If we've done really good on the top half of those, but done really lousy on the bottom half of those. We don't have a wheel. We got a semicircle. Half circle. That doesn't turn very easily. So, visually, I think this works nicely to see we need to spend, we need to not just be strong and good records, we need to not just be strong in marketing, but we have to be strong in all these areas. We have to be able to address all these areas, if, if we want to build the resiliency of the business, not only for greater profitability for ourselves in the next generation, but also to be prepared and ready for the next downturn in the Ag economy. So let's look at these pieces right here. Oh, there's the last one. Sharpen the saw. Maybe that's the most important one. In fact, that's what you're all doing here right now is you're sharpening your saw by being around each other and by being at this session and other sessions, learning some great stuff. Let's talk about profitability. Just as an example here. Over the next four or five years before the next downturn in the cycle, some things to think about. Three primary levers of profitability. How does a business make money? This doesn't-- This is irrelevant of whether it's a farm or an airline. There's three main ways that a business makes profits. The first is they create gross revenues by working their assets. Whether that's tractors and combines and cows, or it's airplanes, businesses work their assets to create gross revenues called asset utilization. The better you work them, the more efficient you are with working them, the more gross revenues you're going to have. Creating net revenues from gross revenues. That's the next part. Once I have the gross revenues, I need to be efficient. I need to be efficient with the expenses that went into that so I can keep as much as that gross revenue in my pocket as I can after the bills are paid. That's efficiency. That's efficiency.

And the last one

leverage. Using somebody else's money to make profitable operations for myself. Those are the three primary ways that businesses make money. So my question to you,

as you go in and get prepared for the next cycle

are you doing a good job at working your assets to get gross revenues? There's a measure for that. It's called the asset turnover ratio. And the neat thing about the kind of agriculture that you folks are in, is you have a lot of ability to benchmark against other people. There's the Ag database that we have here in Wisconsin. There's the FINBIN database that they have at the Center for Farm Financial Management, and lots of other places. There's the ratio scorecard that comes from the Farm Financial Standards Council. There's a lot of information out there as to what a good asset turnover ratio is. I'm thinking it's around 45% or so. Something like that. Whatever it is, you can benchmark yourself, not against the average, but you can benchmark yourself against the top 20% profitable farms that are of your size, of your kind, dairy, or crop, or whatever, etc. You have the ability to do that. So you can see, you can test this out fairly quickly as to where you sit with respect to asset utilization. Are you missing out on some potential resiliency, profitability as a result of asset turnover?

The second one

are you doing a good job being efficient, and thus keeping a good amount of those gross revenues in your pocket? There's a measure for that. It's called the Operating Profit Margin Ratio. And you can benchmark it against the most profitable farms out there and see how efficient you are compared to those who are the most profitable. It might give you room to spend some management time. Are you doing a good job at using your debt financing capacity wisely in order to increase your profit potential? We had those couple slides on the use of debt. Are you like that first example where you're putting money into your pocket because you're using somebody else's money to increase your own profitable operations? There's a measure for that. It's called the debt-to-asset ratio. Benchmarking. I mentioned it already, but you want to benchmark yourself against not the average, but that person you want to be like. Now, I probably should pick-- Since I'm talking to a women's audience, this is probably not the best example to use, the best pictures to use here. I don't think you guys want to look like that, but you get the idea. All right, here's what-- Here's this comparison that can take place, for example. The top of this, let me explain this a little bit. The top of this, here's the operating profit margin ratio. That's the efficiency one. What it tells you is for every dollar of gross revenues, how much of that am I keeping. The ratio score card, which is what comes from the Center for Farm Financial Management folks and it's widely accepted across the industry, says that if you are above about 25%, in other words for every dollar of gross revenue, if you're keeping 25 cents of it in your pocket, then you're considered starting that area of strength. Being very strong in debt ratio. If it's less than 15%, your operation is vulnerable. Here's the asset turnover ratio. For every dollar of assets, how much gross revenue am I creating? If you're creating 45 cents or more for every dollar of assets, that's considered pretty strong. That's the beginning of a strong operation. Now, this is an average of actual farms for crops, for crop farms, from 2005 to 2014. So it's a fairly long period of time. The operating profit margin ratio, 21.6. It's just below that strong part. 46% for asset turnover. It's just above it. You can see where it's at. Dairies haven't fared quite as well. Over that same period of time, 17% operating profit margin, and the dairies have survived well off of the asset turnover. I won't worry about the rest of these statistics. I'll just concentrate on those two. But there's a wide range, there's a wide range here. The lowest 20% profitable farms had a negative efficiency. And they had a 35% turnover ratio. So if that was a farm, if that's where you measured when you looked at this, there's a place to work. There's a place to work in the next four or five years to build resiliency for the next cycle. Same thing on the dairy side. On the other hand, the top most profitable farms, 32% efficiency. Way into the strong area. 25% for dairies. Right at the breaking point there. So you can see there's good benchmark information that you can have to evaluate your dairy. Let's assume that you find out that the asset turnover ratio is indeed low compared to other people. What can you do about it? Well, there's the mathematical calculation for it. So you either want to increase the numerator, decrease the denominator, or both. That's mathematical. But here's how you would do that back at the farm. Can asset productivity be increased? Is there excess machinery out there, excess machinery capacity that's not being used? If so, that may be why we're having a damper on profitability. Leasing versus owning. Asset sharing. Custom hire. Breeding livestock. How many days open are you compared to what it should be? You're not working your asset well if you have too many days open, etc. Other things you can do is increase productivity, mortality rates, conception rates, feed conversions, all those different things that you can look at if indeed you find out that the asset turnover, asset utilization is where you're having a hiccup. If it's efficiency, then you can work, again, with the numerator or the denominator there. Here's some things you could do there. What's your feed waste? Plant populations. Pest control. Lower your input costs. Maybe you could negotiate some lower input costs. Quality of the inputs. Labor is huge, especially for livestock and dairy farms. If there's one thing I see that is causing OPM to be lower, it's probably labor. If that's the case, maybe you need some training. Maybe you need some incentives. Better communications. Better procedures so that that labor is more productive. Here's an example. $1.5 million farm in terms of total assets. They had a 32% asset turnover ratio, 15% operating profit margin ratio. That gave them $105,000 net farm income from operations. Not bad. 4.6% return on assets. That's not the worst in the world. You know? A person could live with that. But if they were to make some changes, and I left the asset value the same, but if they were to make some changes that would increase by one nickel how much gross revenue they're getting for every dollar of assets or how much net income they're getting from every dollar of gross revenue, if they were to increase that by one nick le in both of those areas, then it's $149,000 net farm income from operations. Or, in other words, $44,000 more of cash. Would that be helpful if you were able to get to that point in five years when the next cycle low came? You know, that's what I mean by building resiliency. Can we do things now to build that resiliency? Well, we'd have to stay here for another hour in order to go through all these different areas of the wheel. I just want to look at sharpen the saw. That's what you're doing here today. Continual education Meetings, conferences, web surfing, reading newsletters, memberships, you name it. You're doing it right now with each other. I would love to be able to catalog the number with great ideas that you go home with after conferences like this. Maybe you can align your resources with other people that you meet here or with other people that you have back home. Do you have a kitchen cabinet? What I mean-- You know, the President has his cabinet. Well, you're the CEO of your business. Do you have a cabinet? The lender, the soils guy, the nutritionist. Do you have-- The cow comfort person. Extension agent. I looked over, I had to make sure I said the Extension agent. Right? Do you have that group of people who are willing to come to your farm and sit around your kitchen table, and if you have a low asset turnover ratio, they can go through your records and try to help pinpoint why? They're the experts in their areas. How cool would that be, if you could get them around your table? After all, they're kind of working for you. Right? They don't make money unless they're doing it through you. So, that might-- That's what I mean by the kitchen cabinet. Good records. It's the foundation. You gotta have it. Strategic planning. Do you have one? Better yet, do you have one that you use? Or is it a three-ring binder that's been collecting dust for the last several years? You forgot what's in it. Human resources. Man, it's big. It's big, big, big. Hiring processes, training performance evaluations, all that stuff. May be huge area for improvement, if indeed you have human resources, hired labor, on your farm. Efficient production and marketing, be a top third producer, a top third marketer. Risk management. That's near and dear to my heart. Students in front here are doing this right now. In fact, they're going out to farms like yours, and they're doing risk audits where they're identifying potential risks, they're assessing what the potential impact of those risks are if they happen, and developing mitigation strategies. So, a lot of areas you could shore up your operation from that. The last hour here was a great example. Benjamin Franklin announced that prevention was worth a pound of cure. I didn't realize until I was looking at this, he actually started the first successful insurance company in the United States. So, the more I'm around, the more I learn what Benjamin Franklin did. Financial. Do you do analysis other than what's needed by the tax person or the banker? Do you do financial analysis to help you decide what kind of operational decisions to make? That's a good question. If you don't, that may be a way to build resiliency for the next downturn. What is your debt structure? Final food for thought. We could ignore it. Hope it goes away. But the next cycle is coming, and if you're at the top and things are looking good, the next cycle is coming. Remember that. You will get back there again someday. Be ready when it happens. Be countercyclical. Yeah. I don't say that as trying to predict when the next thing is going to happen and go out and go for broke in the commodity exchange. I don't mean it that way. But can we do things to prepare ourselves for the next downturn in the cycle? We mentioned several. Increasing our working capital, things like that. Can we be countercyclical? Yeah. The most extreme case I ever heard of this was a farm that, prior to 2009, dairy farm, they looked at their tea leaves and said they thought the dairy economy was going the wrong direction. They sold all their cows. And if you remember right before 2009, we had very good prices and very high cow prices. They sold all their cows, they kept their young stock, went through the 2009-2010 period, and about the time they got to the end of 2010, their stock was back into the milking barn again. They made a killing out of that countercyclical way. Now, that's pretty extreme to sell the heard and buy it back again, so to speak. But they were doing it, being countercyclical. Planning. And this is the last one. Dennis Roddy, he's banker out of Kansas. I don't know him personally, but I saw this in an article he wrote. Of having a dashboard, a visual. You know, what are the things that are important to you? Whatever they are, you can see the different areas there, whatever they are, can some of those things be put on your refrigerator, be put on your break room door, be put on your bulk tank? Whatever. Can you have those things there so that you're seeing them constantly, and it's a constant reminder for you as to the areas that will help you build that big, round wheel as you go forward in the future. So, in conclusion, I think-- Well, I don't think. I've got the prices right here. We are in the unhappy part of commodity cycle. I think that's a very true statement. We may be gearing up for a general recession. Now, that doesn't necessarily-- The general economy and the Ag economy don't always coincide and go hand in hand with each other. I didn't mention this much, but the ethanol boom is over. Grain farmers, sorry. The ethanol boom is over. That was a great 10-year ride, but it's over. So, what can we do in the short run? Cash flow. Make it through the bottom of that cycle. And in the long run let's build that big, round wheel. Good luck in the year ahead.

laughter

The second one

You know? I always tell everybody, I got it easy. My paycheck comes whether prices are way up or way down. That's not your situation. So, best wishes with that. Give a call if you have questions and look at building that big, round wheel as you go into the future. Thanks. Hope it was helpful.

applause