Summer Nights, Cow Tours, and…conversations about Cash Flow?

One of the joys of breeding purebred cattle is the summer evening pasture tour.  August is the perfect time of year to see the cows and make an honest assessment of the work they are doing with their calf.   The weather starts to cool off in the evenings, but there is still light to see.   For the cows themselves, udders and feet can be inspected.  Body score can be assessed – are the cows putting it all (or too much/too little) into their milk?  And then there is the calf at side.  Do they follow the dam more? Or is it the sire?  Are the heifers starting to turn into miniature versions of their moms? Are the bull calves developing the swagger that future herd bull prospects tend to get this time of year?  Is there a creep feeder in sight? Or is it all milk and grass?   Not questions to judge.  Rather questions to evaluate, mentally tally, and provide context for future breeding decisions. But it starts with that tour – and it is a gorgeous time of year to be out walking cattle.

It was on one of these evening tours with friends that the topic of farm finances came up. Considering my off-farm occupation happens to be a banker, this topic wasn’t exactly a surprise.  It probably also wasn’t that surprising that I wasn’t part of the conversation.   As my friend and I were walking the herd, discussing cows, calves, bred heifers and pedigrees, our wives were discussing some of the challenges of farm finances.

The discussion concerned budgeting and cash flow.  Our friends had considered every possible expense when they wrote their budget for the year, but they hadn’t considered that the cash flow would be so lumpy.  Farm revenue varies greatly with the season; cattle are only sold a couple of times a year, and there are months (and months) without any farm revenue at all.  Their overall budget was still good but, as a result of cash flow not being very evenly spaced during the year, they were going to make some different business decisions than what they had originally planned.

When Jeanne relayed the conversation to me later on that evening, it got me thinking (even while on vacation) about farm finance, and all the different variables farmers need to consider when making decisions about their operation.  In my more than 20 years as a farm finance professional (aka an ‘Ag banker’), I have been able to experience, tour and get to know a lot of amazing farm families.  I have learned a lot about both good and bad situations that have helped shape our own financial progress.  While I could talk about finances for hours, in the interest of keeping this post at least somewhat concise (for me), I will attempt to limit my thoughts to the Cash Flow of a purebred beef operation, and save some related topics (Budgeting, Working Capital, Contingency Planning) for another time.

Managing cash flow is one of the biggest financial challenges for cow-calf operations.  As a purebred breeder, we receive the vast majority of our revenue in three fashions:  from cull animal sales at weaning, from heifer sales, and from bull sales.   In our case, for all three of those areas, we sell by auction; which essentially means we receive three Cheques a year:  one in September for our post-weaning cull cows and calves, one in January (after late December’s female Equation Sale), and one in March after the Red Deer Bull Sale.  Those three cheques need to be sufficient to cover not only our direct sale expenses, but also our expenses in the other nine months of the year when we don’t have any farm income.   Because of this, we have to be dedicated to our cash flow and budget, and plan accordingly – specifically when we are looking to acquire genetics.  After a sale that exceeds expectations, it is  very easy to get distracted and bid ’just a few more times’ when that ‘donor-quality’ outcross replacement heifer or a new herd bull that would be a ‘total game changer’ strolls through the ring.  But as I value the trust Jeanne and I have with our finances, I always try very hard to stick to budget parameters so that there are as few surprises as possible.  Communicating about the buying decision, and linking it back to the budget and impact to cash flow, makes every one more comfortable about the upcoming months with no cash flow coming in.  (and while our couch is comfy – not exactly somewhere that I want to spend my nights!)

Cash flow is especially important when trying to grow the operation organically from within.  As mentioned in previous posts, I tend to be rather ‘barn blind’, and as such, I really like our group of 25 heifer calves this year.  I would love to retain the vast majority of them but, even if we did have the capacity to develop them all, that decision would have a massive impact on our farm cash flow.

For each (quality) heifer calf, we have four realistic options:
We can sell her as a cull heifer through the auction mart for $1,000 this September
Or, we could sell her as a purebred open heifer this December for $3,000
Or, we could sell her as a bred heifer next December (2019) for $5,000
Or, we could retain her into our herd, generate zero cash from her, and then go through the exact same decision making process starting in September 2020 with her first calf.

The prices I have used are fairly arbitrary (and can clearly be substantially lower in a down market), but regardless of price the concept is the same.  It only makes sense that a ‘sale’ heifer in December should be worth more than a cull in September.  And if you carry a heifer an additional year to sell as a bred, your costs (for feed, pasture, breeding etc.) are going to be higher, and so you ‘need’ to get paid more in order to (at least) break even. It is these first three options that are different methods of being able to turn what you have produced into ‘cash’.

The greatest challenge is the fourth option – that heifer that is retained to expand the herd.  She doesn’t turn into cash until she is culled – hopefully many years in the future. She will also generate zero positive cash flow for the next 24 months, and will only incur costs.  If both the costs and the lack of income are not planned for, then cash flow will be considerably tighter than what was originally expected.  And 24 months is a long time! So when planning for expansion – it is important to remember that awesome replacement heifer(s) takes a long time to generate any income.

For cattlemen looking to expand, the retention decision and its impact on cash flow is only multiplied.  Even for a small operation like ours, making the decision to retain 10 of our 25 heifer calves to increase the size of our cow herd can impact our gross revenue (when utilizing the above illustration) by $10,000, $30,000 or $50,000 over the next two years. Obviously this isn’t a net number, as there are a lot of costs to selling cattle in auction sales, but being aware of the cash flow impact of retaining additional heifers to grow the operation has to be accounted for.  From an accrued accounting perspective, the increased herd will show up as more animals held in inventory (thus the farm will still have generated ‘income’; since it ‘created’ those 10 replacement heifers), but since they are being retained and not being sold for cash, the actual cash in the bank account will not reflect the actual value generated by the farm over that time period.   This is why, during growth phases, farms often feel ‘tight’ as those heifer are eating hay, getting AI’d and increasing  pasture stocking rates – all costs that will be higher when there are more animals owned – but not yet generating cash flow.

For buyers, I think part of the reason bred heifers have become so popular to purchase is that they are a year closer to actually generating cash flow.  Open heifers have that extra year, when they need to be bred, fed and then calved, whereas bred heifers only need to be calved out – and are a year closer to generating a return.  It is always nice if you can ‘clip the coupon’ of a bred heifer and sell the calf for enough to recoup the majority, if not all, of your investment.  This actually happened to us when were purchased Virginia’s Ms. Zillow as a bred heifer back in 2013 – she promptly gave us a bull calf that we sold for more than what we paid for her.  It can also be a (relatively) inexpensive way to luck into your new herd bull.  When we selected BEE Vendetta 243Z at Equation in 2014, she was bred Radium, and her subsequent calf turned into APLX Rambo, our current senior heifer bull who has done quite well for us.   There certainly are situations when acquiring that bred heifer pays immediate dividends!

I also know of buyers that prefer purchasing open heifers.  My dad has long maintained that it didn’t make sense for him to source a bred heifer in the west from a fall sale.  There are a lot of expectations put on a bred heifer if she needs to be transported 3000kms to Ontario, calve out a month later and then breed back in a timely fashion! Selecting open heifers, when they have a year to adjust and can be bred to match his own breeding goals, has always been his preferred approach – even if it takes them longer to generate a return.  From a sellers perspective, I would also suggest that during periods of high demand (or rapid change in an industry), open heifers have at times sold for a premium over bred heifers.  If I recall correctly, this was the case during the height of Fleckvieh Fest in the mid-90’s, and also occurred in the dairy sector once the Genomics craze created upheaval.  Getting new genetics to market earlier (and potentially allowing buyers to multiply them quicker), meant quicker returns.

I can’t call myself a banker and not talk about debt as an option to assist with cash flow.  The challenge I find with debt, isn’t so much the borrowing of it, but that it has to be paid back.  The cow-calf sector is historically low-return, highly cyclical, and dependant on variables outside of a farmers’ control.  So while borrowing money might be an immediate solution, that commitment to a payment for the next number of years may make cash flow that much tighter in the future.  This year is a great example – cattle prices have remained strong, but with most of Alberta in drought conditions, winter feed is scarce and expensive, and the cows will be coming home much sooner than originally expected.  Adding a payment to the equation, would just add that much more stress (and potentially force more of those ‘retained’ animals to market early).  With borrowing money, there are exceptions to every rule (my team would suggest my favourite answer to questions is ‘it depends’)!  There may be situations like a dispersal/ability to purchase a package privately where it makes sense for genetic reasons to take on debt in order to make a substantial investment – but always remember that there is a future payment coming that needs to be built into ongoing cash flow.

The last point I want to mention about cash flow, is that since the industry has such low returns, it makes communication that much more important.  It is extremely rare that 100% of operational revenue is generated solely from the cow herd.  The majority of cow-calf operations are supplemented by non farm income (like in our case, where both of us work off farm), or they have another farming enterprise (generally crops) that helps make farm cash flow at least a little less lumpy.  Here in Alberta, surface revenue cheques from oil/gas well leases also tend to be timely!  It is still important to evaluate the cash flow impact of an expansion decision though – and have that conversation with all the key stakeholders in the farm.  Communication is so important in farm businesses, and it is essential that everyone is on the same page when the operation is evolving.  No one likes surprises involving finances – and communicating when one line of business (or off-farm job) may need to help support the cattle business is helpful for everyone.  No one wants to have to worry about how groceries may get put on the table, simply because the impact of an expansion plan wasn’t fully thought through or clearly communicated.

That is one of the downsides of the purebred cattle business.  Purebred cattle aren’t ‘liquid assets’ that can be sold quickly for what they are worth.  In theory, the animals retained as breeding stock have genetic potential that should make them worth more than a typical commercial animal.  It is always an option to run them to the auction mart – but once weaning has passed and additional costs are incurred; those costs are not recouped from liquidating the animals at the weekly sale.  Selling them tends to need to be planned, so they can be marketed appropriately, interest obtained and a fair return received.  A private treaty sale could happen unexpectedly, but even with that option it is essential to ensure the touring farmer doesn’t think there is desperation for a sale.   It takes time to orderly market purebred cattle for what they are worth – and time might be in short supply during a cash flow crunch.

In our friend’s case, they recognized an upcoming challenge early and were able to start the conversation with each other as to what impact and direction they would need to take – all before even talking to a banker!  It has long been my experience that given time, space and communication, seemingly complex (or difficult) decisions can get made with all parties being satisfied.  It really is that simple.  Plan.  Communicate.  Revisit.  Recognize that things will never turn out exactly as you originally intended .  Be willing to adapt.  But most of all – enjoy.  This is a great time of year to be a cattle breeder.  So let’s enjoy our summer nights – and fill them up with cow tours, great friends and awesome conversation.

Until next time,

Dennis