As anyone who followed the debate over the USMCA trade agreement last fall will know, Canada’s dairy industry is a regulated one. As a result, business interruption calculations involving dairy farms will often contain a number of moving parts that do not occur in other industries. This article provides an overview of how to quantify these losses in the following four main steps:
- Calculate the milk production shortfall
- Apply the appropriate market price
- Deduct saved expenses
- Add any increase in expenses
1) Production Shortfall
To calculate the milk production shortfall, we must first calculate what production would have been absent the incident. Each province in Canada has a milk board (for example, Dairy Farmers of Ontario). The milk board issues daily milk quota (measured in butterfat content) to each dairy farm operation and the farm must not exceed the quota they are allotted (after considering over and under credits). Quota can also be purchased and sold each month when available. Therefore, understanding the quota that a farm has is the starting point for projecting milk production.
Next, we must ensure we are considering any key factors that would alter the milk production of the operation, such as:
Was the business increasing (purchasing) or decreasing (selling) their quota prior to the incident? Were they increasing the number of head of cattle prior to the incident?
Herd management practices
Production can be impacted by many factors such as overcrowding, heat stress, feed, etc. Understanding what the drivers of historical production changes are is imperative to determine whether these drivers would also affect production during the loss period and would thus need to be considered in projected production.
Percent of quota filled
The farm operation may not produce exactly 100% of the quota available. If it is reasonable the business would not produce at 100% of quota, an adjustment should be made.
Incentive days utilized
In order to meet increased demand, the milk boards may offer incentive days, which allow the farm operations to produce above quota without utilizing “over” credits or incurring a penalty. It is important to consider when these credits are available and if the business historically took advantage of these incentive days.
The last step to calculating the production shortfall is to understand what the business is doing with their quota following the incident. If the business operation is leasing quota to other farms that have capacity to utilize the quota or if the business has surviving cattle that are being milked at other locations, the actual revenue that the business still receives must be deducted from the projected production. If a portion of this outsourced production is paid to third parties, these payments would be considered as an increase in expenses as discussed in further detail at Step 4 (“Increase in Expenses”).
The price of milk is market driven and can fluctuate from month to month. The revenue paid on the milk statement is typically presented net of various deductions such as transportation, administration, etc.
3) Saved Expenses
After calculating lost revenue, the next step is to calculate any reduction in variable and fixed expenses as a result of the incident.
In situations where the entire herd has died, savings in operation expenses may be significant (feed costs, veterinary costs, breeding costs, etc.). However, if there are cattle that survived and are still at the loss location, many of these expenses may continue.
If cattle are being boarded or milked elsewhere, it is important to understand the nature of the agreement between the parties, and who is covering each of the ongoing expenses of caring for the surviving cattle, as this type of arrangement might result in an increase in expenses.
4) Increase in Expenses
The final step is to consider any increase in expenses as a result of the incident. As mentioned in Step 1, this could relate to payments to other farms that are caring for, and milking, any surviving cattle; it is not uncommon for the farms temporarily housing the insured’s cattle to receive in the range of 70% of the production from those cows.
An example of a potential increase in expense would be an increase in chemical fertilizer costs (if the insured also grows crops) due to loss of the manure from the perished herd.
Dairy farm losses can be complex with many moving parts, and it is important to understand the specific farming operations and how they have been impacted as a result of the incident. However, the four steps outlined above should provide a framework to ensure no major components of the loss measurement are missed.
At MDD, our accountants have worked on numerous matters across Canada involving business interruption issues.
By Conor Paxton.