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Decisions4Dairy: Long-term business planning

Published 20 July 16

In the third of a series of articles under the #Decisions4Dairy – Optimising Revenue theme, AHDB looks at the volatility in farm prices and how longer-term planning can help business decision-making.

The sharp drop in milk productionwe are seeing in June suggests that supply has finally responded to the low prices seen in the market over the past two years. Globally, the slowdown in production has meant prices have started to move up again on wholesale markets. This is beginning to flow through to farmers in the UK where we have seen some increases in prices paid to farmers.

So, how should farmers interpret and react to the recent increases in price? Also, how do you make plans to put the business on a profitable footing when prices move so quickly?

Given the long-term nature of the dairy production cycle, farmers have limited options to enable a quick reaction to short-term price signals from the market. By the time new business plans are put in place and fully implemented on the farm, it’s almost inevitable that near term prices (ie monthly) will be different.

The graph shows how milk prices in the UK have become more volatile as markets become more affected by global events. The irregularity in pricing, along with variations in production arising from weather, makes it hard to assess whether a business can be profitable in any one year, or if it needs to adjust.

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Source: Defra, AHDB Dairy

Alternatively, when prices are averaged over a longer period, the short-term impacts of weather or price extremes can be smoothed out. In the graph, the rolling five-year average is calculated and, although reflecting changes in the market, it does it in a smoother fashion. Essentially, it smooths out short-term volatility, which in reality is difficult to respond to, as well as smoothing out annual weather extremes and, therefore, gives an informed view of ongoing performance.

For an individual farm business, having a handle on both rolling average costs and price can give a strong indication of profitability and competitiveness over the longer term. In addition, with farmers now able to average profit over five years for tax purposes, the incentive to look at profitability over a five-year period is clearly there.

Taking a five-year view on price and cost makes managing profitability a long-term proposition. However, cash flow remains a short-term item to manage – especially during periods of low price. So, to be successful, businesses must not use cash flow as a measure of profitability and need to have separate strategies to manage liquid assets and profitability.

This is just one area of work being looked at by the Volatility Forum, which AHDB is leading.