• Klassen: Winter forecast for feeding margins

Canadian government fiscal policy is negative for the Canadian dollar. Tax increases, ongoing government deficits and overall left leaning policies do not bode well longer term. Recently, the cancellation of the “Energy East” pipeline has also set a negative sentiment for Canadian dollar ownership amongst investors. The elimination of a $15 billion direct injection from private enterprise along with the multiple spinoffs removes the floor of the currency. This erodes confidence in future development of other infrastructure projects for Canada’s major industry. The Canadian dollar has no friends when major negative news such as “Energy East” comes to the forefront.

Canada’s trade deficit widened in August from the previous month to the fifth largest on record. Exports have fallen for the third consecutive month and are now down on a year-on-year basis. The merchandise trade deficit stood at a seasonally adjusted $3.41 billion, up from a revised $2.98 billion shortfall in July. This data suggests that the pace of economic growth has dropped sharply. It would not be a surprise if manufacturing sales continue to decline in upcoming months. Third-quarter GDP will probably come in near 2.5 per cent compared to the second quarter growth of 4.5. The unemployment rate will be relatively stagnant for the remainder of the year. There is no major stimulus from the government coming forward and government construction season is coming to an end. Canada added 10,000 jobs in September and the unemployment rate stood at 6.2 per cent. While there was a 102,000 loss in part-time jobs, there was a gain of 112,000 full time jobs. On a positive note, wages showed a year-over-year increase of 2.2 per cent. Given the current environment, it is hard to justify further strength in the economy over the next four to six months. The Bank of Canada has cooled its talk of further rate hikes with widening trade deficit, stagnant inflation and tempered growth projects. The wage increases are positive but this is the only factor that would warrant further interest rate hikes.

In the U.S., the trade deficit narrowed to US$42.4 billion on a pickup in exports. It is important to note that when merchandise and services are incorporated into the data, the U.S. runs a slight surplus with Canada. For the most part, if Canadian oil and gas exports improve, then the trade balance would be about equal. Trump and the Republicans are on the road for major tax cuts which will put U.S. businesses at a major advantage and this will cause the U.S. trade deficit to narrow further. Lower taxes will bolster inflation and enhance job growth. If we use the New Zealand example, lower taxes will also result in greater government revenue due to the spinoffs in the private sector and greater consumer spending. The U.S. unemployment rate fell to 4.2 per cent in September, although non-farm employment fell by a seasonally adjusted 33,000; average hourly earnings rose 2.9 per cent from a year earlier. The U.S economy is at the latter end of an expansionary phase but until economic data suggests slower growth, there’s no reason to expect a cooling period.

It appears that Federal Reserve Chair Yellen is leaning towards a rate hike in December and then two or three consecutive rate hikes in 2018. This should coincide with the Trump tax cuts and temper the upside in the equity markets. At the same time, the Federal Reserve is starting to liquidate its balance sheet of longer-term bonds. Talk in the industry suggests it will liquidate about 10 billion per month and build this up to 50 billion per month. Demand for long-term bonds is quite strong so this should not significantly affect the bond markets. Selling bonds drives down the price and increases the yield, which is actually somewhat positive for the U.S. greenback against other major currencies.

U.S. crude oil inventories appear to be declining. Longer term, if we continue to see stocks decline, the crude oil market could continue to strengthen and thereby support the Canadian dollar. Amongst world traders, the Canadian dollar has once again become a resource-based currency with price direction related to crude oil, metals and other commodities. Monetary policy has taken a back seat for the time being.

In conclusion, the current environment suggests that the Canadian dollar will have a difficult time sustaining any rally. Our largest trading partner appears to be pulling the Canadian economy along despite the left-leaning fiscal policy of the federal and Alberta provincial governments. Further rate interest rate hikes by the Bank of Canada and positive economic data would be needed to warrant any strength. I’m looking for the Canadian dollar to trade in a range from $0.78 to $0.815 over the next four to six months. I have a weaker bias in the next two-month timeframe.

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“They are larger, the amount of debt is greater, the fact that we’re not seeing a higher number doesn’t mean there isn’t considerable distress out there,” said Todd Langel, a lawyer with Faegre Baker Daniels in Des Moines, Iowa.

Speaking at the Grain World conference in Winnipeg on November 15, Langel said the factors causing insolvencies on most farms these days are generally tied to low commodity prices and a lack of knowledge of how to deal with shrinking margins.

“The U.S. producer has gone through a relatively recent period of profitability due to higher prices during the last cycle (five years ago) and that has allowed some producers who don’t have quite as sharp a pencil to continue,” he said.

The competition for North American farmers is also getting tougher due to cheaper production costs in South America.

However, Langel says Canadian farmers may have a few advantages over their counterparts to the south.

“I think that a number of Canadian producers are larger and have a greater degree of sophistication in some of the operations that may give them an advantage,” he said. “They also may pay more attention to risk management strategies.”

Another factor that is becoming more common is that an increased number of farmers are using corporate structures or limited liability companies to define their operations.

This may work to their advantage, but it also tends to muddy the true number of farms that may actually be going under, according to Langel.

“They may be using organizational methods that don’t tend to get put into bankruptcy,” he added.

According to Langel, what can often occur is the farmer may choose to simply dissolve the corporation or LLC as opposed to putting it through a court-monitored restructuring process.

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Two producers can use the same production practice. One could be making a profit and the other losing money. It all comes down to the margin. The economics of a production practice has to show an adequate profit to cover opportunity costs, depreciation and inflation. I also have to be able to cash flow the practice in order for it to be financially viable.

Economics and finances are two different sets of numbers. A production practice could be profitable, but not financially feasible. Or you might be able to cash flow a venture but it is not profitable. We need to have both the economics and the finances in order to have a viable business.

I would like to look at the economics side of the business today by looking into the gross margin analysis.

I have taken numerous private industry education courses, Ranching for Profit, Holistic Management, Low Cost Cow/Calf, TEPAP, just to name a few. All of them have contributed to my business management system because they taught me an amazing tool that I had never even heard of before, the gross margin analysis.

It can show me where my business is failing and gave me the ability to make good choices. Sometimes it even shows you that the best decision is to stop doing something. As a farmer myself, I know that we complain all the time about three things. The weather, of course, is No. 1 but I can’t control that. After weather we complain that we don’t have enough time or enough money. I have found that by understanding how to run a gross margin, you can free up time and make more money by focusing on the profit centres that are making a positive margin and possibly even shutting down some profit centres that are producing negative margins.

By breaking my operation into profit centres, I am able to see which practices are working and which are not.

A gross margin analysis is quite simple. If you have a big number and you subtract a small number from it, you have a positive margin. We just do this many times for all the different profit centres.

Wait, let me back up. A profit centre is one component of your business. You may have many that make up your farm, such as a cow-calf profit centre, a land profit centre, a grain profit centre, a hay profit centre, a grazing profit centre or a feeder profit centre. Every farm is different. Hopefully, your gross product (the big number) minus your direct costs (the little number), for each profit centre gives you a positive gross margin. If not, you can see what needs to be fixed. Either the big number needs to be bigger or the small number needs to be smaller.

Each profit centre can be broken down to determine the margin it contributes to the total margin. This in turn then has to cover all of your business overhead costs. If it does, you are making a profit. Now this analysis has to cover all of the costs, even the non-cash costs.

After you have paid for all of your labour (I do not like the term unpaid labour) and all of your cash costs, you need to cover depreciation, opportunity cost and inflation.

Depreciation is the loss in value of an asset over time. It is calculated by subtracting the salvage value of an asset from the purchase value divided by the number of years owned. Most of our equipment does depreciate but our cows also depreciate. The longer she can stay in the herd, the lower her depreciation. In theory, every year, the depreciation value of an asset should be accounted for and saved for when that asset needs to be replaced. When that time comes, you use the money saved up plus the salvage value of the asset to replace it. Are you covering your depreciation each year?

Opportunity cost is a measure of your management. Most people have a hard time understanding opportunity cost. You don’t see it in your finances, but you need to account for it in your economic analysis. Look at it as an interest charge on that investment. The money that could be earning you a return somewhere else. Is it earning enough of a return as a cow or as a tractor? I like to use an opportunity cost of 10 per cent. Somewhere, my money invested should be able to return me 10 per cent. An easy way to determine your opportunity cost is to use your highest interest rate you are currently paying on borrowed money. An asset could be sold and its value could pay down the loan and save you the interest charges on that loan. If your loan interest was eight per cent, then the opportunity cost on your assets could be eight per cent.

Inflation can vary but let’s say an inflation rate of three per cent is average. Will the money you have today be worth the same tomorrow? Will you still pay the same for a litre of gasoline 10 years from now as you do now? Not likely, so we have to make sure our business will be ahead of where it is today 10 years from now by accounting for inflation.

Now include this all into your gross margin analysis and see if you are making a profit. It is a powerful tool. I can’t emphasize enough the importance of understanding the economics of a farm business. As fun as the production side of your operation is, it’s the economics that makes a profit.

You are the manager of your business and it is up to you to manage. If you haven’t done so already, I challenge you to find somewhere that teaches gross margin analysis and learn it. That was the biggest breakthrough I ever had in my business.

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Once I have determined profitability and weighed the risk involved, I then have to determine whether or not I can afford to do it. Can I finance it, or cash-flow it? For my finances, I run a simple business cash flow, which is linked to my personal cash flow as well. I have an easy to use Excel spreadsheet for my computer that keeps me on top of my finances throughout the year.

Economics and finances are two different calculations, which is again different from my income tax. We need to be careful in our businesses. I have seen many times that a bank will gladly lend you money if you can finance it, even if the venture is completely and totally economically unsound! It is your job to determine profitability; your banker only cares about finances.

I learned years ago the importance of being proactive on my cash flow. By pro­active, I mean looking ahead six to 12 months and predicting any shortfalls on my monthly net cash flow and having the time to adjust and replan to avoid any issues. This might be just selling something earlier or possibly even meeting with a banker early on to deal with a financial crunch. The alternative is to be reactive on my cash flow and have my banker calling me to tell me that I am overdrawn. Bankers are not so easy to deal with if you are always reactive. They are much happier if you are proactive.

My cash flow is simple. The top has a monthly breakdown of my cash inflow. Each profit centre will have a row with how much cash is entering the bank account and when. Some entries can be very straightforward and others can be more complex. The complex entries I will link to another sheet of the workbook and detail out the calculations that come up with that cash inflow.

As an example, for my custom grazing profit centre, I have a separate sheet that breaks down the different pastures and the number of animals that graze on them. I then add in my grazing rate and it automatically calculates the monthly revenue off of each pasture. It then totals up each pasture for each individual month and transfers that calculation back to the main page as one single entry each month. Each profit centre you have might have its own calculation sheet. Once all of the extra sheets are filled in, the main page automatically totals up each month in the columns and each profit centre is totalled up in the rows.

Next we look at our monthly cash outflow. (It is funny how there are always so many more entries in the outflow). Again, all of the cash expenses are detailed and broken down month by month. Similar to the inflow, the more complex calculations can be linked to another sheet. An example of this is that my land rent is detailed on a separate sheet showing who gets paid how much rent and when. The totals are then transferred back as a single monthly entry to the main page in the cash outflow area.

The spreadsheet then of course calculates your monthly net cash flow and rolls the balance from the end of the month to the beginning of the next month for a 12-month period. At a glance this can tell me of any upcoming shortfalls that I might have in the upcoming months. The negative account balances show up in red. If this is the case, I need to adjust and replan to get each month back in the black. I also have this linked to our personal cash flow as our wages and shared utilities can be linked along with the business.

It may take me a few hours to set this cash flow up at the start of the year but once it is up and running, a few minutes each month is all that it takes to monitor, adjust and resave it. It is the easiest cash flow I have seen and it only takes a little bit of knowledge in Excel to be able to operate it. As you adjust one entry to replan your current month, it automatically updates and flows that correction through to every month ahead.

Why run a proactive cash flow? Well, it not only keeps my banker happy and allows my business to run smoother, but I have found the most beneficial bonus is peace of mind. It takes a lot of the stress out of running a business. Even if there is a forthcoming financial issue, I am aware of it and have time to plan for it.

The reactive cash-flow plan is not a lot of fun and is not recommended for any business plan. Be proactive.

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That seems like a big jump but the people putting this material together point out a $3 provincial levy and $2.50 national levy would have a producer paying 0.43 per cent of the receipts from a calf at 2014 prices to pay for all the lobbying, marketing, promotion and research supported by the cattle industry, 0.27 per cent on a fed animal.

Still checkoff discussions at provincial cattle meetings don’t always hinge on the amount of dollars involved. Not everyone agrees with this proposal so it is bound to generate some discussion before it comes to a vote across the country.

This is a provincial decision. Each province has a national levy for beef on the books so they could conceivably increase the national portion of their checkoff and pass it on to Canada Beef Inc. If every province passed the increase it could become a national levy and be applied against imported beef. Last fiscal year the national checkoff agency brought in $900,000 on beef imports.

If it isn’t approved by enough provinces there will be little choice but to start cutting back on the work of Canada Beef and the Beef Cattle Research Council, the two main arms for carrying out the national strategy.

A combination of inflation, declining cattle numbers and changes in government funding have reached the point where the status quo won’t be enough to even maintain the current services let alone reach the lofty goals established in the national beef strategy.

Just one example: the second five-year Beef Research Cluster has shared funding of $15 million by the federal government and $5 million from the national checkoff plus some provincial and private sources. It’s projected the industry could not afford to sign a third Research Cluster agreement without an increase in the national checkoff.

As you may recall the four pillars of the national strategy focus on beef demand, competitiveness, productivity and connectivity.

The goal of the beef demand pillar is to enhance beef demand and as a result enhance carcass cut-out values by 15 per cent over the next five years. This was to be achieved by focusing on domestic and global marketing, market access, validating and enhancing the Canadian Beef Advantage, consumer confidence and social licence. All worthy goals but the target may need some retooling. In August the cut-out value on AAA carcasses was already up 16 per cent on last year. Of course the way the market has been correcting in the past few weeks we could be below that level by year-end.

The goal of the competitiveness pillar was to reduce production cost disadvantages compared to our main competitors by seven per cent over the next five years. This will be achieved by focusing on reducing the regulatory burden, access to competitively priced inputs, maintaining and enhancing key research capacity, and economic, social and environmental sustainability.

The goal of the productivity pillar is to increase production efficiency by 15 per cent, through focusing on genetic selection, research and development, technology development and adoption, and enhanced information flow.

The fourth pillar, connectivity, may in fact end up being the most significant leg in this four-legged strategy. The goal here is to enhance industry synergies, connect positively with consumers, the public, government, and partner industries by actively addressing industry issues.

The creation of this national strategy alone has been a major exercise in connectivity as it brought all the different sectors to the table to hammer it out. That is something that even a couple of years before didn’t seem possible. McDonald’s sustainable beef project is another example of where this new-found sense of co-ordination within the industry is already paying off.

Now we will find out if they can bring this same sense of unity to raising the money needed to keep this plan on the rails.

The $2.50 figure comes directly from this same planning process. Last summer the associations involved first hammered out the strategy, then went through each step in the four pillars to budget what would they need to put this plan into action.

That came to $9.5 million for marketing and promotion ($18 million to $19 million in total), $3.3 million for research ($11 million to $12 million). Depending on the activity as much as $6 in government or industry money can be leveraged for every $1 of checkoff collected.

If you want to learn more or have your say about this increase in the checkoff this would be a good year to show up at your provincial organization’s regional or annual meetings.

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