To illustrate this, dairies participating in the Dairy Business Analysis Project were sorted into two groups on the basis of average total liabilities per cow. Only those dairies providing complete and verifiable information were included in the average. The adjoining table lists selected financial performance statistics by total liability group. While the statistics presented in the table are based on operating conditions unique to Florida and Georgia, several concepts are demonstrated that are important to any dairy business.

The first point of interest was the close relationship between financial and operating efficiency. This can be observed by looking at the differences in profitability between the two groups. Net farm income from operations of $1.12 per cwt. milk sold of the low liability group (less than $1,500 total liabilities per cow) was $1.73 above the ($0.61) loss of the high liability group (greater than $1,500 total liabilities per cow). This was due to a difference in cost control ability as total expenses of $16.85 per cwt. milk sold for the low liability group were $2.06 below the $18.91 of the high liability group. Total revenues were slightly higher for the high liability group ($18.30 per cwt. milk sold), reemphasizing the cost control ability of the low liability group. These differences translated into a 5-percentage point difference in the operating profit margin, as the low liability group posted 4% profit while the high liability group had a (1%) loss.

A valid argument may be that those dairies with higher debt will always have higher interest expense. This higher debt may not always be a bad thing, especially considering the age of the business and the ability to leverage investments. However, investigating liability composition illustrates another concept about financial efficiency, namely how effectively debt is being used in the business.

Three major types of liabilities are investigated in the adjoining table, accounts payable, operating notes, and term notes. Short term notes and capital leases are other types of liabilities but they were of negligible composition for these dairies so they are ignored for this analysis. Accounts payable are those liabilities in a non-structured note that are owed to another business or vendor for operating expenses. Examples include the feed bill, supplies, machinery repairs, etc. The low group had accounts payable of $25 per cow, 85% below the $168 per cow of the high liability group. This was a substantial difference as accounts payable often carry high interest rates (18% and higher are not uncommon). Even though accounts payable are easy to acquire and often the first source of financing in times of tight cashflows, they are often the most difficult to manage of all liability types.

Operating notes are any structured note due with a year that are used for operating expenses. Examples include lines of credit and seasonal loans for crops to name a few. The low liability group averaged $166 per cow, 23% above the $135 per cow average for the high liability group. While the low liability group was actually higher than the high liability group, the real story is in the relationship with accounts payable. The low group had higher operating notes (to purchase feed, etc.) but they did not finance the purchases, on average, with accounts payable. Conversely, the high liability group had more accounts payable per cow than operating notes per cow. Either operating notes were not feasible, not granted by lenders, or payables were a more convenient source of financing for the high liability group.

Term notes differed substantially between groups. These include any note used to finance capital items with a maturity in excess of one year. The $1,812 per cow average for the high liability group of was 3.2 times the $566 per cow average of the low liability group. This difference may have more to do with the age and maturity of the business. However, this is a substantial encumbrance on future cashflows, with average total liabilities of $1,812 per cow in excess of the value of most cows. This puts increased pressure on cows to generate revenues just to service debt, let alone generate returns to management.

These differences in liability composition between groups were further reflected in the times interest earned ratio. The times interest earned ratio was computed by dividing net farm income from operations by total interest expense. If the broad view of financing is taken such that all debt is borrowed in anticipation of generating future profits, this ratio will measure the effectiveness of financing activities in attaining that goal. The low liability group averaged 8.67, 9.74 points above the (1.07) negative average for the high liability group. The negative number indicates the operating loss of the high liability group. It also revealed that the cost of debt service (i.e. interest) was well above earnings and indicative of poor financial efficiency.

It is obvious from these numbers that the financing activities directly affected the financial and operating efficiency of these dairy businesses. Liability composition, although not widely discussed, is an important factor determining cash flow ability and interest expense. Dairy managers need to control both the level and structure of liabilities, something that is usually not disclosed in the fine print of most loans. Without deliberate control, debt service and interest will negate any profits and erode the operating efficiency of the business.

Selected 1997 Financial Performance Statistics Grouped by Total Liabilities per Cow.
Category	Total liabilities per cow1 group
	0-1,500	>1,500
Number of dairies	16	13
Number of cows	984	1,994
Milk sold per cow (pounds)	17,538	16,569
Total revenues (per cwt. milk sold)	$17.97	$18.30
Total expenses (per cwt. milk sold)	$16.85	$18.91
Net farm income from operations2 (per cwt. milk sold)	$1.12	($0.61)
Asset turnover ratio3	0.99	0.72
Operating profit margin4	4%	-1%
Rate of return on assets5	5%	0%
Total assets per cow6	$3,382	$4,773
Interest expense (per cwt. milk sold)	$0.36	$0.96
Times interest earned ratio7	8.67	(1.07)
Total liabilities per cow1	$768	$2,116
Liability composition (per cow)
Accounts payable	$25	$168
Operating notes	$166	$135
Term notes	$566	$1,812
1Total liabilities per cow computed as average between beginning and ending liabilities for year divided by average number of cows. 2 Net farm income from operations was computed as accrual adjusted revenues minus accrual adjusted expenses. This represents the return to unpaid management and capital. 3 The asset turnover ratio was calculated by dividing gross revenues by average total assets. 4 The operating profit margin was determined by adding interest expense to net farm income from operations, subtracting a $50,000 charge for unpaid management, dividing the remainder by gross revenues. 5 Rate of return on assets was calculated by adding interest expense to net farm income from operations, subtracting a $50,000 charge for unpaid management, dividing the remainder by ending total assets. 6 Total asset per cow computed as average between beginning and ending total assets for year divided by average number of cows. 7 Times interest earned ratio calculated by dividing net farm income from operations by total interest expense.

[1] Contributing authors include R. Giesy, P. Miller, M. Sowerby, B. Tervola, D. Solger, P. Joyce, T. Seawright, C. Vann, and M. DeLorenzo.  Also L. Ely, Animal and Dairy Science Department, University of Georgia.