Programs of Texas Cooperative Extension are open to all citizens without regard to race, color, sex, disability, religion, age or national origin.

Issued in furtherance of Cooperative Extension Work in Agriculture and Home Economics, acts of Congress of May 8, 1914, as amended, and June 30, 1914, in cooperation with the United States Department of Agriculture. Chester P. Fehlis, Director, Texas Cooperative Extension, The Texas A&M University System.

Feedyard Closeout

Retained Ownership Alliance Evaluator

For Beef Cow-Calf Producers

Author:

James M. McGrann Doug Richardson

Jim McAdams 5/5/03

2

Feedyard Closeout Retained Ownership Alliance Evaluator

For Beef Cow-Calf Producers∗

The purpose of this spreadsheet evaluator is to organize feedyard and carcass data to evaluate the performance of the cattle feeding activity for cow-calf producers that are retaining ownership as a participant in a beef cattle production and marketing alliance. This decision aid will help organize feedyard and packer data and do the necessary data processing to provide consistent reports that facilitate lot analysis and comparisons between lots of cattle. Data is also summarized in a database format for statistical analysis separate from this decision aid. There are several levels of analysis that are useful in evaluation of the retained ownership activity which include:

• Financial Performance – Market Valuation - feedyard direct cost financial analysis at the market value of feeder cattle. Consistent with a traditional feedyard closeout report in which the cost of feeder cattle entering the finishing phase is valued at market price.

• Financial Performance – Total Cost Valuation - cow-calf through feedyard total

accumulated financial cost analysis using accumulated cost valuation of feeder. If data is available in this format, the total cost valuation of feeder cattle provides a more accurate reflection of true business profitability.

• Economic Performance – Total Cost Valuation - using accumulated cost and including

an opportunity cost on the capital investment. In addition to the financial or accounting cost, an opportunity cost that is charged for owned land (what it could be leased for) and owner equity capital (what it would earn in an alternative investment or by how much it would reduce interest if used to repay debt). Opportunity cost represents the return that could be received for a resource in its next best use. Economic cost represents the cost “if all resources” earned their opportunity cost or a use forgone.

• Economic Advantage of Retained Ownership - with feeder at net market value if sold

and the capital invested at an opportunity cost. This level of analysis illustrates the effect of making the decision to retain ownership rather than selling as a feeder. Given the net income obtained from retaining ownership minus the unrealized sales value of marketing as a feeder interprets if this decision was favorable to the business.

• Financial Performance With Standard Values - feedyard direct cost financial analysis

at the market value of feeder cattle. This analysis enables the lot analysis with constant ∗ Prepared by James M. McGrann, Professor and Extension Management Economics Specialist and Doug Richardson, Research Assistant, Department of Agricultural Economics, Texas Cooperative Extension, Texas A&M University and Jim McAdams, McAdams Ranch Management and Vice President, National Cattlemen’s Beef Association. 5/5/03 .

Comment [JM1]:

3

feeder cattle, carcass price, choice-select price spread and feed and yardage cost. By eliminating the pricing effect on different lots of cattle being marketed at different times of the year, a standardized price model can be used to more accurately make a comparative analysis between the different lots.

The feedyard direct cost analysis is the common feedyard closeout reports where only

direct feedyard costs are reported. Feeders are valued at market value or their opportunity cost. The feedyard margin is labeled profit (loss) but is actually a feedyard margin.

From a cow-calf producer’s perspective an alliance should be measured in terms of how the retained ownership affects total business equity (profitability). This requires a determination of the total accumulated cost from the cow-calf and preconditioning segments through the finishing segment. This analysis also includes indirect costs beyond the feedyard direct cost and general and administrative (G & A) costs of the total business.

The economic analysis considers the opportunity cost of the alliance in terms of what the feeder could have been marketed for and the capital invested in the next best alternative.

For an alliance to be sustainable over the long run there must be an economic advantage to retain ownership over selling the feeder and investing the capital. Considerations must also be made for the added price and production risk associated with retained ownership. Determining Standard Values If producers wish to evaluate their production and financial performance on a group of cattle and use this information to form a comparative analysis across different lots, a standardization of prices and cost values can be used. This analysis is comparable to the traditional feedyard closeout that uses a market valuation on feeder cattle going in. As seasonal price differences can have a big impact on the feedyard margin realized from the sale of a particular lot, the goal of this analysis is to assign standard prices, as to allow the margins to be influenced by cattle performance rather than prices at that particular time period. Below are the standardized items that are used in the analysis. Feed and Yardage- can be determined by taking the average of the actual feed and

yardage cost across the different lots being analyzed. This measure is reported on a $/Ton basis.

Opportunity Cost of Operating Capital Equity- an opportunity cost on operating

capital could be standardized for the calculation of economic net income. This represents what return would expect to receive if money was invested in the next best alternative.

Percent Equity in Cattle- the amount of equity invested in the cattle being fed should be

standardized between the different lots being analyzed.

4

Percent Borrowed for Feed and Other Costs- the same percentage of borrowed capital should be used in lots being compared. The percent of borrowed capital is used in determining the return on assets (ROA) and return on equity (ROE) of the particular lot.

Interest Rate on Borrowed Capital- a standardized interest rate should be consistent

between lots being compared. The interest rate is used to determine the interest expense associated with any borrowed capital.

Base Cost and Weight for Feeder Cattle- the price of feeder cattle going in should be

determined by using a standard base price. The price should be adjusted for weight and a standard slide should be used to compensate for the differences in base weight and the actual weight of the feeder cattle going on feed. Using an average price determined by a particular market can help in determining what prices to use. If a freight cost is figured into the cost of the feeder cattle, make sure all lots include freight. If not, freight should not be used when determining a standardized price.

Base Price of Carcass- a standardized base price of carcass can be determined by using

an average of fed cattle prices during a particular time-period and dividing by the different dressing percentages between the lots.

Choice-Select Spread- the choice-select spread should be fairly consistent with spread

values observed during the time-period your cattle were sold. This standard spread is used in determining the premiums and discounts associated with grid pricing.

Careful attention must be applied when determining the standard prices to use in this analysis. Once standard prices are determined and entered into the program, a second review of the data being entered should be done to make sure that the values are in fact standardized between the different lots being analyzed. Input Data

The production and financial data is recorded for the lot of cattle in the first sheet. This data is a combination to the cow-calf producer’s data, the feedyard and the packer data. This provides flexibility to accommodate different reporting forms. The following sheets are linked in the data input sheet.

• Feedyard Closeout- Financial Performance- Market Valuation • Business Analysis- Financial Performance- Total Cost Valuation • Standard Values- Financial Performance with Standard Values • Lot Summary • Lot Database Summary • Production Graphs • Financial Graphs

5

Operation of the Spreadsheet

Most of the data is entered into the first sheet with the exception of the Standard Values Analysis. All cells in blue are unprotected and should have values or a zero. Care must be taken to insure all data from the three sources is complete including the cow-calf, feedyard and packer. It is common to have the lot divided into several sales or partial closeouts. The spreadsheet accommodates this, providing data for each sale. A drop-down box is included on the Input Data screen that helps in entering data for partial lot sales.

It is optional to use the Standard Value Analysis as this has to be set up to address specific questions related to feeder pricing and the carcass grid and feed cost.

Note: When saving lot data each lot needs a unique file name and is saved by using the

“save as” command. Reports

The summary report is linked to several sections that are linked back to the data input and calculation sheets. The report sections begin with the production and marketing – pricing performance. This is followed by the reports from each analysis described above. The database report records data generated in a format so it can be summarized to compare lots and establish cause-effect relationships. Statistical analysis can be used to establish relationships to evaluate performance and production alternatives and marketing decisions. Graphs The reporting of key production and financial measures are also put in a graphical presentation to better see the performance of the particular lot being analyzed. The production and financial graphs are contained in two separate worksheets that focus on a few key measures taken from the lot summary report. If a Standard Values analysis is completed for a particular lot, the financial graphs worksheet contains a chart that summarizes the values that were standardized across the lot. Questions to Address The reports and data can be used to address a number of questions including: Was the participation in the alliance profitable to the cow-calf segment and was it advantageous versus selling the feeders? The next question is what are the key factors that explain the net margin and ROA for each lot and across the lots. When prices are standardized would the conclusions to these questions change?

6

After these questions are addressed it is important to determine based on the lots evaluated, under what conditions and prices would the alliance be favorable to the cow-calf producer given performance of the cattle evaluated? Key Decision Information The description below provides information and definitions that are useful in evaluation of results. Finishing cattle is, by definition, a margin business. It is value-added versus cost of gain or added cost. The feeding margin is most frequently offset by a negative marketing margin or the difference of feeder selling price and purchase price, referred to as the buy/sell margin, or rollback, as purchase cost of the lighter cattle is normally greater than sales price.

Marketing margin is the net payweight sales for the weaned calf or purchase payweight of the stocker (feeder) based on sales and inventory adjustments times buy/sell margin or the rollback or roll-up (positive or negative margins between cost of buying and selling price). For a negative marketing margin, the cost of gain has to be less than its market price (sales price) to have a positive net income.

Feeding margin is the sales price minus the cost of gain times the net payweight gain. It is a measure of how much the value of gain exceeds the cost of gain. Under normal buy-sell prices, there is a negative marketing margin. The feeding margin must offset this negative margin for the enterprise to generate a positive net income. To generate a profit, the marketing margin plus the feeding margin must be positive. To accurately calculate these margins for evaluation of growing and finishing alternatives, decision makers need the following data:

(1) Payweight of weaned calf, stocker (feeder) cattle (2) Payweight purchase cost of cattle (3) Net payweight when marketed (4) Payweight gain (5) Full cost of gain – all cost including overhead and interest cost (6) Payweight net sales price (7) Number of head sold net of death loss

The formulas for calculating margins are as follows: ** Marketing Margin ($/hd) =

((Total Purchase Payweight * .01) * (Sales Price − Purchase Cost)) / Head Out Feeding Margin ($/hd) =

((Sales Price – Cost of Gain) * Net Gain * .01) / Head Out

7

Net Income ($/hd) =

Marketing Margin + Feeding Margin

** All prices and costs are in $/cwt, weights are in pounds, and margins are dollars per head out. Payweight to payweights accounts for death loss. The most important product of the cattle cost accounting system is the cost of gain as it

measures both efficiency and competitiveness of the growing or finishing enterprise. The sum of marketing margin and grazing or feeding margin is profit per head. Financial and Economic Advantage of Retained Ownership and Margins is a measure of the financial and economic costs (including opportunity cost of capital) that is positive or negative. That is, is marginal revenue greater than cost? Net margin is based on head out. This margin shows the source of a positive or negative margin based on head out. Recall from the margin definition that net income can be positive only if the marketing margin can be offset by a positive feeding margin. Annualized Net Return on Assets (Capital) Financial ROA is the annualized return on assets (ROA), including net margin objective, and is the net income plus cash interest cost plus the target margin objective divided by annualized capital (asset) requirement to support the enterprise. Capital is adjusted for the time cattle are fed. The reason interest is added back in the ROA calculation is that it had been calculated out in determining net income. Interest represents a cost of capital, so it must be added back to net income to calculate an income before interest to determine what net income is capital.

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

Appendix A- Definition of Terms

Accumulated Cost is the sum of direct and indirect production costs, general and administrative

cost or the total operating cost plus finance cost associated with production. Average Daily Gain (ADG) is the net payweight weight gain divided by head days. This weight

is adjusted for death loss (deads are in) as only live cattle payweight are counted. Average daily gain is total gain divided by days on feed.

Breakeven Cost is a cost component divided by the amount of saleable product. The costs

included must be defined before a breakeven can provide useful information to a decision maker. A break-even that does not cover full cost is very misleading. Feedyards never calculate a “full cost” breakeven. It is a feedyard direct cost breakeven. Producers must use closeout information and add the full cost of the feeder and the business’s G & A costs.

Depreciation is the value that accounts for the use of a capital asset over time. Direct Expenses are expense items that are directly related to production activity such as feed

and yardage, health and feeder cost. Economic Analysis includes the consideration of the opportunity cost of equity capital when

marketing the cattle at weaning. The analysis serves as a guide to finding the optimal use of resources to generate the highest net income possible for the operation.

Economic Cost is, in addition to the financial or accounting cost, an opportunity cost that is

charged for owned land (what it could be leased for) and owner equity capital (what it would earn in an alternative investment or by how much it would reduce interest if used to repay debt). Opportunity cost represents the return that could be received for a resource in its next best use. Economic cost represents the cost “if all resources” earned their opportunity cost or a use forgone.

Feeding Margin is the finished net sales price minus the total cost of gain times the net

payweight gain. This is a measure of cost of gain versus the sales value. Feeding Cost of Gain is the traditional cost of gain provided by the feedyard closeout report.

Costs included include feed and yardage, processing, health and other direct feedyard expenses but do not include the producer’s general and administrative, finance or management costs.

Feedyard Margin the feedyard direct cost analysis is the common feedyard closeout reports

where only direct feedyard costs are reported. Feeders are valued at market or their opportunity cost. The feedyard margin is labeled profit (loss) but is actually a feedyard margin.

29

Financial Analysis focuses on determining the accounting cost (cash and non-cash), profitability or change in equity, and repayment capacity of the enterprise or business being evaluated.

Financial and Economic Advantage of Retained Ownership and Margins is a measure of the

financial and economic costs (including opportunity cost of capital) that is positive or negative. That is, is marginal revenue greater than cost? Net margin is based on head out. This margin shows the source of a positive or negative margin based on head out. Recall from the margin definition that net income can be positive only if the marketing margin can be offset by a positive feeding margin.

Financial Costs include cash costs, depreciation, and non-cash adjustments, such as accounts

payable, accrued interest, etc. These costs are recorded and reported in the business accounting system. The financial cost does not include opportunity cost of resources like lease equivalent or owned land and interest on equity capital.

Head out is the total of cull and finished cattle marketed or the total cattle in minus death loss. Payweight Price is the net income from sale after adjustments for freight and marketing costs.

Payweight is the net weight after shrinkage for the cattle. Marketing Margin is the weaning weight times the rollback or rollup in price, or the positive or

negative margin between initial feeder price and the sales price. Net Payweight Gain is the difference between net sales or payweight and weaning weight. Net Margin is the difference between the value of the net sales and the original feeder value and

added cost of the segment. The net margin is made up of two components, marketing margin and feeding margin.

Net Payweight Sales Revenue is the revenue received per cwt after shrink and all freight and

marketing costs are accounted for. Opportunity Cost of Capital is the rate of return for the next best investment alternative with

similar risk. This is an economic cost. Cash interest paid is an accounting finance cost. If there is a business debt, the interest rate on debt is a good indicator of opportunity of capital.

Owner Operator Labor and Management compensation should be included in the production

cost calculation at a level equivalent to the salary required to hire a non-family member to provide an equivalent service. Compensation in excess of this amount must be considered capital distributions in order to reconcile the retained earnings and statement of cash flows. This makes a sole proprietor’s cost comparable to a corporate business’s calculation. Owner manager costs need to be included in production costs.

30

Partial Closeout takes into account multiple or different sale groups of cattle that came out of the same lot being fed. This practice is common amongst many beef cattle alliance programs in which sorts are more frequent. The entire lot production and financial performance is the summation of all partial closeouts within that lot.

Payweight In is the net beginning weight. Payweight Out is the net weight out after shrinkage (deads are in). In other words, it is net-to-

net payweight. Preconditioning and Backgrounding is often used interchangeably. This is the phase of

production between weaning and selling or transferring to a stocker or finishing phase of production. Preconditioning is a 30-60 day period. Backgrounding is normally used to describe cattle that are confinement fed for a longer period between weaning and sale as feeders.

Price Slide is a price adjustment for a weight that differs from the base weight. It is very

common for feeder and stocker buyers to include a price slide to the agreement to protect the price they pay for cattle at the base contract weight. If the weight exceeds the base, say $90 for a 500 per pound calf, then a deduction is made. For example, say the price quote is $90 per cwt for a 500-pound feeder with a $6 slide. If the feeder weighs 550 pounds, then the price would be $90 – ($.06 × 50lbs.) or $3 or $87 per cwt weight. The 500-pound calf is worth $450 per head. The 550-pound calf is worth $478.50, not $495 (550 * $90). Be sure to understand the terms of the agreement and have accurate weights on the cattle.

Profit (Loss). Great care must be exercised in reading reports in the cattle sector labeling the

value profit or loss. Most frequently in feedyard and other cattle reporting, these numbers are gross margins (gross revenue minus direct costs) and do not include overhead and owner labor and management costs, which are required to calculate a true profit or return to business equity.

Rate of Return on Equity measures the rate of return on equity capital employed in the farm

business. The higher this value, the more profitable the business. Rate of Return on Assets can also be called return on investment. This ratio gives an indication

of how productively the assets are being utilized. A low return on assets could indicate inefficiencies in the use of assets; low net income due high feeder cost, high feed costs, poor production performance or low finished cattle price or a combination of these factors.

31

Standardized Valuation is the feedyard direct cost financial analysis at the market value of feeder cattle. This analysis enables the lot analysis with constant feeder cattle, carcass price, choice-select price spread and feed and yardage cost. By eliminating the pricing effect on different lots of cattle being marketed at different times of the year, a standardized price model can be used to more accurately make a comparative analysis between the different lots.

Total Unrealized Sales Value is the net sales revenue that is projected if the calves are sold at

weaning after shrink and marketing costs. The weight price and marketing costs are critical.