Production and Financial Standards for the Pork Industry

Earl Dotson

Vice President

Education, Environment and Production

National Pork Producers Council


There is probably no other industry in the world today experiencing such rapid change as the U.S. pork industry. With these changes has come an ever-increasing challenge for pork producers to position their businesses to be profitable into the next millennium.

As a well known economist stated recently, "The emerging reality of the twenty-first century for all agricultural industry will be that those businesses which are organized around knowledge rather than tasks will have the opportunity to create wealth," or in other words be profitable.

It is becoming increasingly evident to many within the industry that a set of production and financial standards are needed. Standards would be one of the keys to this knowledge based pork industry. These standards will serve as the extended knowledge base for the new pork industry.

Ask six pork producers or pork industry people to give a definition of what a gilt and a sow are and you are likely to come up with six different responses. These are words used daily in the pork production business yet the animals being described with these words can vary greatly. If you were to ask these same people how their production records tie in with their chart of accounts, you will likely get a blank stare. If there was ever a time pork production must be treated as a business, the time is now. How do we as people in the pork business communicate, compare and improve if there is no common language? How can the pork industry communicate on production and financial business matters when there is no common language?

On October 5, 1995, the National Pork Producers Council assembled a Task Force called the Joint Committee on Industry Standards. The committee consisted of 75 people representing pork producers, lenders, CPA's, educators, consultants, industry representatives, and software companies.

The charge of the Task Force was to develop financial and production guidelines for the pork industry with these goals in mind:

1. Promote uniformity in financial and production standards for the pork industry by presenting methods for financial and production reporting which are theoretically correct and technically sound;

2. Present standardized definitions and methods for calculating financial and production measures.

3. Identify certain financial and production measures common to all areas of the country and all pork producers and establish standardized methods of calculating those measures.

The development of these industry standards will allow producers, lenders and others to better understand the impact production and financial practices have on debt, equity, and capital. The committee members consisted of pork producers, lenders, Certified Public Accountants, educators, consultants, industry representatives, veterinarians, and software company representatives.

Two main committees were formed from the first meeting - production and financial. The production committee formulated common definitions and formulas to measure and compare the biological progress in a pork production unit. Whereas, the financial committee created a standardized chart of accounts and adopted/added to the "Sweet Sixteen" Farm Financial Ratios.

After several meetings these two subcommittees sat down to compare notes and draw bridges between the two groups' efforts. It became apparent why such and effort had not been undertaken before. Although these "standards" were to be compatible with both committees, that was far from the case. Between terminology associated with new production practices and the variety of definitions for current terminology, it is no wonder the financial community and pork producers do not understand each other.

Obtaining standards common with both the production and financial committees required going back to the basic building blocks of each. For production, this is biological terminology and for financial, it is the chart of accounts. Several financial and production subcommittee meetings later, a chart of accounts was created, which matches up with biological terminology.

The first impression of what these two groups have done should be positive. We can now finally track and compare production and financial efficiencies on a farm as well as compare to other farms. But, keep in mind, if we could not do this before and now we can, something must have changed. You will notice many new definitions/formulas; some of the old standby terminology/formulas are gone. The new terminology more clearly defines what is being described.

Once the terminology and formulas were approved, the cost accounting group began to formulate detailed cost analysis formulas. Beta testing of all the formulas, using actual, on-farm data will be conducted to ensure the accuracy and feasibility of all formulas. The formulas were developed as a reporting vehicle. Virtually any current raw production data can be analyzed using the new standards.

Concentrating on production records, the following example will give an indication as to how the terminology has been standardized. The terms: "SEW Pig (MEW, Isowean, etc.)," "Feeder Pig," "Gilt," "Sow" and "Boar" are currently used in the industry to describe pigs at various stages of their life cycle. These terms are locally descriptive but not universally descriptive to the point where they can be plugged into common formulas and be mathematically repetitive. What is the definition of a sow? What is the definition of a gilt? For example, one producer classifies a gilt as a female which has not farrowed her first litter and another producer classifies her as a female who has not been mated. Both definitions are correct in their own usage; however, when applied in a universal formula (or in the balance sheet) the results are very different.

To get back to the original question "What is the definition of a sow and a gilt?" For many this is an easy question which should not be given two seconds worth of time. However, does everyone have the same definition? A sow commonly is defined in one of three different ways:

A. Sow = the whole female population

B. Sow = excludes unmated and mated parity zero females

C. Sow = includes only the mated females

"So, what's the big deal? There are a few different ways to define a sow and a gilt. I know how I define them. How does this impact my farm (or the farms I work with)?"

It may not if a pork producer does not, benchmark their farm to others, use consultants or advisors who look at a variety of farms or if they never borrow money. Many lending institutions look at a variety of production efficiency measures to get a feel for how good or poor of a manager an individual pork producer is in addition to their financial stability. In determining the management ability of a pork producer, lenders will commonly look at Pigs per Sow per Year (PSY).

In theory, PSY is a good summary of how efficient the breeding herd is because it gives the number of pigs produced (output) from a given number of sows (input) over a period of time. The reality is that PSY is worthless when comparing one farm to another. Here is why¼

One reputable lender uses the following PSY values as a method of determining the ability of a prospective client:

<19 PSY poor manager

19 to 23 moderate manager

>23 good manager

Let's evaluate a sample farm to determine if how a gilt or sow is defined has any impact on PSY. The sample farm has an inventory which can be described as follows:

1,060 total breeding females

60 unmated parity zero females (gilts)

128 mated parity zero females

20,100 pigs weaned

12 month period

System 1

Sow = the whole female population

Calculation - 20,100 / 1,060 = 18.9 PSY

System 2

Sow = excludes unmated and mated parity zero females

Calculation - 20,100 / 872 = 23.1 PSY

System 3

Sow = includes only the mated females

Calculation - 20,100 / 1,000 = 20.1 PSY

Summary

System 1 - 18.9 PSY producer is a poor manager

System 2 - 23.1 PSY producer is a good manager

System 3 - 20.1 PSY producer is a moderate manager

All the numbers were calculated with the same raw data only the definition of sow changed between the systems. A producer's abilities can range from poor to good with the current set of definitions. Is there a need for standard terminology in the pork industry?

The Production Standards Committee has developed a more comprehensive list of terms and definitions to describe the various stages of a pig's life cycle. The following terms can also be found in the chart of accounts.

Weaned Pig - a pig that has been weaned but not yet transferred to the nursery production stage.

Nursery Pig - Any weaned pig which is at least 29 days of age and up to 70 pounds of weight. Associated with the nursery stage of production.

Finisher Pig - Pigs beyond the nursery stage being raised for sale.

Prospective Breeding Female - Any female which is being fed for the purpose of future introductions into the breeding herd. This includes weaner females, nursery pig females and mature females being raised under the same conditions as other growing and finishing pigs.

Unmated Breeding Female - A female introduced into the breeding herd (characterized by the act of changing diet formulations to those found in the breeding herd) but not yet mated. These are normally classified with parity zero.

Mated Breeding Female - Any breeding female which has been mated at least once and has not yet been removed from the herd.

Breeding Female - An unmated or mated female kept for breeding purposes.

Boar - Any male pig in the herd for breeding purposes.

Intact Pigs - Male pigs that have not been castrated and have not been kept for breeding purposes.

This is just one area where the Production Committee has standardized terminology to fit today's modern pork production business. The production standards committee has developed a more comprehensive list of terms and definitions to describe the various stages of a pig's life cycle.

Terminology was not the only area addressed by the production committee. The methodology by which data is analyzed was also reviewed. In the past all data was calculated for a given period of time. This is referred to as "time-slice analysis." The drawback to this type of analysis is that it only includes those records that have activity in the report time period. For example, farrowing rate for December would include all females farrowing in December divided by the number of sows bred to farrow in December. This is accurate for biological analysis but does not accurately reflect the economics, since some to the females may actually farrow the first part of January. Consequently, feed, housing, labor, etc. expenses would not be accurately calculated. To overcome economic inaccuracies of "time-slice analysis," the production committee implemented "cohort analysis." Cohort analysis is to production records what accural accounting is to the financial community. The definition of cohort is: "A group of animals that share a common event within a defined period of time."

So let's expand on the previous example using a cohort analysis: the females bred for December, but actually farrowing in January, consumed inputs but did not produce pigs. Through cohort analysis, all females bred to farrow in December would be included in the analysis, even if they farrowed in January. This analysis results in a much more accurate measure of a farm's production efficiency.

The development of financial standards for the pork industry is just as important for several reasons. First, financial standards help ensure adequate debt and equity capital is available to pork producers. Secondly, such standards will provide each pork producer, and others involved in the pork industry, with a way to uniformly define costs, profits, return to capital or assets, and other financial formulas. Next, to provide each pork producer with a way to define their financial results from capital and labor. And finally, to provide each pork producer and the industry a way to compare individual operation results, the financial results achieved from adopting new technology, and other key financial improvement information.

In the past, individual pork producers have had unique or inconsistent methods of recording revenue expense, inventories, and assets. This has contributed to reluctance of many lenders and other capital providers to fund worthy pork production projects. Unfortunately, pork producers and their consultants could not compare costs, profits, and other financial measures. That is why many producers cannot tell whether they are competitive and how or where they might improve. As more new technology is brought into the pork industry, producers will be challenged to understand the financial implications of adopting it.

The financial standards subcommittee addressed these and other areas of concern by focusing on four key areas:

1. Adopting the Farm Financial Standards Council's {FFSC} recommendations for financial data accumulation (accounting practices).

2. Adopting the FFSC "Sweet Sixteen" ratios plus two additional ratios that are pork specific.

3. Assembled a management-oriented financial chart of accounts, coordinated with the production standards committee, to provide consistent definitions for each account.

4. Recommended standard financial report formats for the following:

Income Statement

Balance Sheet

Statement of Change of Owner Equity

Statement of Cash Flows

We believe the adoption of these financial standards will enable pork producers to realize significant financial benefits. Of course, we realize most producers, accountants, and software firms will have to improve, or at least change, some of their chart of accounts, accounting practices, and financial reporting. Still, we believe the payoff will be significant in several ways:

More access to credit and capital.

Improved profit potential.

The ability for each producer to determine how they compare, how new technology applies to their operation and overall, how competitive they are.

The new terminology and formulas allows producers to communicate with other producers, lenders, consultants and other industry people on a standardized level. This process will not come easy. Educating industry people about the new terms and then implementing them into every day activities is a major challenge.

WHY ARE PRODUCTION AND FINANCIAL STANDARDS IMPORTANT?

Producers who know their own operations and their competitor's as well, can position themselves for future competitiveness and profitability. However, without standardized means to calculate key production and financial measurements, comparisons between farms yield unreliable results. Once established and employed, these standards will a) improve producers' understanding of their own operations, b) provide a fairer means of calculating contract payments and cost-plus pricing, c) improve access to capital, d) facilitate benchmarking among farms and regions, and e) provide a means to carry out applied research both internally and externally for the benefit of producers.

Benchmarking for instance, begins by gaining a true understanding of the systems at work on the farm, their strengths and weaknesses, and then evaluating them in the light of the best systems in the industry. This demands a comprehensive system of production and financial records which are accurately recorded. Standardization of those methods will bring about the ability to comprehensively assess a production operation and gain invaluable knowledge about the interactions between production processes and financial outcomes.

The first step for a producer is to understand their own system of production. Are they measuring production accurately? Production figures don't mean much unless they are accurate. Are pigs accounted for accurately in each stage of production? Do physical inventory counts reconcile with computer-generated numbers? How many "unrecorded" deaths are there in their system? How many "adjustments" are necessary at the end of the month? Before making benchmark comparisons, a producer's own system needs to be as accurate as possible.

In the past, one of the main concerns of consultants, both independent and those employed by the extension service, was to convince producers of the necessity of keeping good records. Those days are over. Today, a basic set of records is expected in order to make any kind of rational decision concerning a swine operation. The challenge for producers is to use the data that is available from record-keeping systems to make good decisions.

Before productivity can be analyzed, producers must understand their record-keeping system. Many record-keeping systems assist producers in keeping accurate inventories and compiling historical data. The more useful systems are also diagnostically oriented. Record-keeping systems should use terms and standards commonly accepted in the industry. NPPC recommends the adoption of the standardized production and financial system being completed.

Some production and financial packages are able to interface, allowing the exchange of data and eliminating the need for double-entry of some data. But these packages are uncommon currently, and, by necessity, their ability to interface is usually restricted to one or two other programs. Therefore, a person using a selected production program may be restricted in their choice of a financial program if they want compatibility.

Good management information not only identifies problems but offers solutions. Without some integration of production and financial information, valuable data is limited to identifying "symptoms" of problems. As a result, management decisions are derived from fragmented data rather than from the type of comprehensive data that provides the insight needed to come up with an optimal solution that is also economically sound.

An example would be a low pigs/mated female/year performance reported from production records. This is a symptom. When the production figure is integrated with financial records, the information may provide a measurement of lost revenues and the costs to make improvements. We now have the comprehensive data needed to offer economic solutions.

Production and financial information that is prepared separately - that is independent of each other - can be costly and lack integrity. Integrating production and financial information can streamline the process and reduce the cost of obtaining good management information.

At this time, the best advice we can give is to select the best production and financial programs to fit your needs, regardless of interface capabilities. As interface capabilities become more common, packages that provide ease of data transfer and that meet the needs of producers will become available. If producers' software providers do not plan to integrate the NPPC standards into a future release, at least as an option, it will be increasingly difficult to justify using that system as competitive pressures in the industry rise.

COMMON PROBLEMS WHICH CAN BE OVERCOME WITH NPPC STANDARDS

Although comparing one swine operation's productivity with that of others is useful, it can be unreliable. The NPPC project to standardize production and financial measures is the important first step in alleviating the problems.

Common mistakes made in comparing production efficiency and throughput measures from farm to farm are:

Being influenced by reports of extreme values in a variety of production parameters, including feed efficiency, building costs, pigs/sow/year, and costs of production. If the value sounds too good to be true, it probably is. Many of these reports are for systems that are new, enjoying the "honeymoon" period and do not represent long-term sustainable levels of achievement.

Comparing the performance of production systems that are too different to allow meaningful comparisons;

Comparing the performances of operations with record-keeping systems that are different or that calculate measures differently;

Making important decisions based on rumor or the latest "hot" issue affecting the industry. Producers must be able to separate fact from fiction and make decisions based on information relevant to their own operations.

A common problem that we observe with record-keeping software for production systems is that producers often create their own template from one of the common spreadsheet programs. The resulting program may be narrowly focused on the individual producer's pet concerns and may not address the issues that a consultant or lender believes are important. Often, these homemade programs report only historical data, without providing any diagnostic or problem-solving help on current problems. These programs usually limit the producer's ability to benchmark as well. Switching to a standardized record-keeping system will enhance your ability to benchmark with your industry.

Comparing certain operations is like comparing apples and oranges. It doesn't work with many of today's record-keeping systems. Following are factors that can vary from operation to operation and invalidate comparisons. Producers and their consultants need to be aware of these factors and others that can affect benchmarking comparisons. To avoid invalid comparisons, you must understand the record-keeping system that is being used, when the data are recorded, the lag-time from when events occur to when data are entered into the records program, the data integrity level of the farm, and the processes that are followed to ensure accuracy of the data.

One example of this is the Timing of Gilt Entry and Cull Sow Removal:

Gilts may enter the breeding herd on the day of purchase, the day they are moved from the finishing area if home-raised, or the day they are mated. Further complicating gilt entry data is the advent of weaner-breeders and feeder-pig age breeders being sold or transferred within cooperative arrangements. Cull sows may be removed from the herd the day the culling decision is made, the day they are moved from the breeding area to the cull sow area, or the day they are sold. These decisions affect reported data for nonproductive days, litters/sow/year, and pigs/sow/year. The NPPC standards define female breeding animals and if used by cooperating parties will facilitate valid comparisons.

NPPC production standards define a breeding female as: an unmated or mated female kept for breeding purposes. A breeding female day is defined as one live breeding female for one day (measured at the end of the day). This creates the definition of the breeding female inventory as: the sum of mated breeding female inventory and unmated breeding female inventory.

The average breeding female inventory is used as the denominator in measures like pigs weaned per breeding female (compared to the common industry measure "pigs per sow per year"). The average breeding female inventory is calculated as:

Total Breeding Female Days

Number of days in the interval

The standard of what is a breeding female is determined by intention and by management. Breeder weaners for instance are not considered part of the breeding herd inventory until they are both intended for breeding and are managed for breeding as evidenced by a change in diet or ration.

Confusion over this issue, the definition of the breeding female inventory, results in enormous differences in related efficiency measures which use this in the calculation. Some common systems in use today count the breeding herd inventory as 1) any breeding female over seven months of age or 2) Simply ask the producer to give a number for the "sows" in inventory. It is left to the producer to determine whether animals in isolation or in conditioning for cull sales are included.

WHAT CAN PRODUCTION AND FINANCIAL STANDARDS DO?

Ultimately, the "standards" will allow producers, lenders, consultants, educators, and other allied industry representatives to speak the same language when comparing production and financial business matters. Once established, both production and financial benchmarks will allow pork producers and their advisors to better understand the impact of production practices, new technology, debt, equity and capital on their operations. As producers learn more about their operations, they will be able to ask more of the right questions to get the information needed to guide their decisions.

Integrated financial and production information has many management applications. For example, producers who keep financial records primarily for tax purposes are obtaining only a small fraction of the information needed to manage. Producers need two sets of financial books, one set for tax purposes, and another set for financial reporting purposes.

Tax records are good for the Internal Revenue Service but poor for management use. Also, tax records should not be used to seek financing. Competent lenders are not interested in tax records. But they are very interested in financial statements based on Generally Accepted Accounting Practices (GAAP). If financial statements are integrated with production records an entirely new level of quality management information will become available. This information will allow producers to more precisely apply management decisions.

Additionally, such uniformity will permit collection of data for historical tracking and comparative analysis of pork production systems. As this information is assembled over time industry benchmarks can be developed. Benchmarks can be used in many ways, but one important use is comparing data to others in similar situations.

In non-agricultural industries, such as home construction, trucking or food service, information is available that allows business owners to compare how a business is performing to others in that industry. This allows business owners to know how their business is performing in nearly all key areas compared to others, in that industry.

The pork industry currently has no such information available. But as the guidelines are developed by NPPC these types of benchmarks may become available. They will serve as significant management tools for producers and others in the pork industry.

In summary, integrating production and financial information has many advantages. Once established, both the production and financial benchmarks will allow pork producers and their advisors to better understand the impact of production practices, new technology, debt, equity, and capital on their operations. As we learn more and more about our operations, we will be able to ask more of the right questions to get the information needed to guide our decisions. The process of collecting, testing and updating the information and formulas is ongoing. Continuous updates and program development will help pork producers and their support industries keep pace with this dynamic industry.


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