Weathering the cycle's end

Beef producers should implement specific management tools to guide them through this decade's price downturn.

We know a typical cattle cycle lasts 10-12 years. We also know cattle inventory cycles are the fundamental factor behind beef-price cycles. Such random shocks as the 2002 drought or the discovery of BSE in North America modify the cycle but don't remove it.

Figure 1 presents the profit implications of the latter half of the last cattle cycle (1992-96) and first half of the current cycle (1997-2005).

U.S. cattle numbers began increasing in 2004, and increased again in 2005. As U.S. producers continue to build cattle numbers, beef prices are projected to come under more pressure — just as in past cattle cycles. Producers should implement specific management tools to guide them through this decade's price downturn.

Three management tools

Producers should annually monitor three “green-flag/red-flag” business management signals as they take their beef cows through the projected price downturn of the current cattle cycle's second half. The bottom line of these three business management tools is the herd's key annual green-flag/red-flag economic benchmarks.

  1. Net-cash-flow account (NCFA) is based on the cow herd's direct cash costs. These include the cash costs of growing farm-raised feeds and forages for the cows, servicing debt (interest and principal payments) and drawing family living (if appropriate) from the beef cow herd profit center. Depreciation on cows, cow equipment and haying equipment aren't cash costs and shouldn't be considered in the cash-flow analysis.

    NCFA is the business's bottom-line cash-flow benchmark and is used to answer the question, “Are my beef cows generating a positive cash flow, or are they being subsidized by other sources of cash flow?”

    If the beef cows are generating a positive NCFA, the benchmark is a “green flag.” If generating a negative net-cash flow, the benchmark is a “red flag.”

    A multi-year, net-cash-flow benchmark trend for your herd should be established and closely monitored, especially during the cattle cycle's expansion phase.

  2. Net-value-added account (NVAA) is an economic profit account based on farm-raised grains, hays and pasture priced to the beef cows at the local fair market value (opportunity costs); assets valued at market value; actual interest paid on borrowed money; and non-cash depreciation on cow facilities and cow equipment (not haying equipment). Principal payments and family living draw, on the other hand, aren't part of economic costs.

    NVAA is an accrual-adjusted, net-income account where annual inventory adjustments are also considered. The NVAA and NCFA are two distinctly different business-management tools.

    NVAA is a business's bottom-line (profitability) benchmark. It's used to answer the question: “How much added economic value did my family generate by running the beef cow herd?”

    In general, this added economic value is really the only “true” profitability measure of the beef cow profit center.

    Rancher-driven accounting systems, and even most accountant-driven ranch accounting systems, aren't accrual adjusted. This is a serious shortcoming for managers, as they can't know their operation's true profitability.

    A positive NVAA benchmark generates a green flag, while a negative one generates a red flag and implies the family received no economic payment for its three contributed resources. In fact, it indicates the beef cows didn't even pay market price for farm-raised feeds.

    Repeated years of negative NVAA benchmarks (red flags) from the beef cow profit center suggest beef cows aren't a profitable use of ranch resources. Repeated red-flag years can lead to financial jeopardy.

  3. Net-financial-return account (NFRA) is based on assets valued at book value (costs minus depreciation taken to date), costs (direct and indirect) of producing farm-raised feeds, cost of pastures grazed, and actual interest paid on money borrowed for capital assets. Pasture and farmland used for farm-raised feeds are valued at actual acquisition cost, not at current market value or opportunity cost.

If the pasture and farmland is paid for, there's no land cost. Family living draw is also taken into account in the calculations.

NFRA is the bottom-line benchmark used to answer the question: “Are my beef cows adding equity to my family business or consuming business equity?”

A positive NFRA bottom line implies the business is generating equity. A negative NFRA (red flag) implies equity is being consumed, which must be remedied immediately or the business may fail.

Integrated Resource Management (IRM) experiences suggest beef operators who recognize their herd's red flags early best survive the cycle's price downturn. This is because they can address business weaknesses before matters become serious.

The last cycle's lessons

As an Extension specialist, I generated herd assessments for IRM cooperators for the complete 1990s cattle cycle. When beef prices were high, all assessment benchmarks for typical beef cow herds were sending green-flag signals. The typical beef cow business generated a positive NCFA, a positive NVAA and a positive NFRA.

As the beef-price cycle turned down at mid-decade, a distinct order of red flags appeared. In the first year (1994), some herds generated NCFA red-flag signals.

Typically, the other two business benchmarks were positive and sent green-flag signals. We now know the early NCFA red flags were a signal of more serious financial problems ahead.

As beef prices continued to fall in 1995, we began seeing red flags from the NVAA herd assessment. The NFRA benchmarks, however, typically were still positive.

As beef prices continued to fall in the third year (1996), some herd's NFRA benchmarks turned negative (red flag). This implied such ranchers were consuming equity capital, and long-term survival was in question.

The order red flags appeared in this downturn is significant. The first red flag to pop up was negative NCFA, the second was negative NVAA returns and the third was a negative NFRA. The NCFA red flag typically was seen two to three years before the dreaded NFRA red flag showed up.

The key to financial performance was early detection and immediate corrective action. Operations without these red-flag benchmarks waited for their banker to detect financial stress.

When beef prices rebounded from 1997-2000, the NFRA flag turned green first, followed by NVAA, and then NCFA. Some herds had three years of negative NCFA, and a few had up to five years. Without a financial reserve, three years of negative NCFA can substantially weaken a ranch's financial structure.

Multiple years of negative NCFA turns into negative NVAA and then into the dreaded negative NFRA. Multiple years of negative NFRA is a sure way to ensure the cow herd won't survive the cattle cycle. The key in preventing financial stress is early detection of, and quick response to, the red flags.

To order Harlan Hughes' CD, “How To Make The Cattle Cycle Work For You,” send $25 to: Harlan Hughes, 30 Ramble A Road, Laramie, WY 82070.

Harlan Hughes is a North Dakota State University professor emeritus. He lives in Laramie, WY. Reach him at 701/238-9607 or [email protected].

Click below to view Figure 1.

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