Farm Management

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Farm Management

• Chapter 6
• The Income Statement
• and Its Analysis

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What is an Income Statement?
An income statement is a summary of revenues and
expenses as recorded over a period of time.
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Figure 6-1 Relation between balance sheet and
income statement
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Identifying Revenue and Expenses

• Revenue revenue should be recognized as soon as
  a commodity is ready for sale, whether or not it
  is actually sold
• Gain or loss on sale of capital assets
  difference between sale price and book value
• Expenses all expenses incurred in producing the
  revenue for an accounting period should be
  included

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Net Income Statement, defined

• Includes Revenues and Expenses

• Revenues Expenses
• NET FARM INCOME (NFI)

• Net Farm Income Profit

• Also known as a Profit Loss Statement

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Inventory Changes

• Crops and Feed on Hand
• Market Livestock
• Accounts Receivable
• Prepaid Expenses
• Accounts Payable

• Does this sound familiar??

CURRENT ASSETS on the BALANCE SHEET
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Inventory Changes
Accounts Payable Beg Inv End Inv Inv Change

• Current Assets have a life of lt 1 yr
• Balancing inventories accounts for the changes in
  these assets

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Depreciation and Capital Adjustments

• Breeding Livestock
• Machinery Equipment
• Buildings and Improvements
• Other Assets

• Does this sound familiar??

INT and LT ASSETS on the BALANCE SHEET
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Depreciation and Capital Adjustments

• Intermediate and Long Term Assets last gt 1 yr
• Depreciation calculates amount of asset used up
  during the last year

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Depreciation

• How much of the asset is used up during the
  year?
• Lots of methods to calculate
• Straight line
• Asset Value (cost basis) ? Years of Life
• Declining balance, Double-declining balance,
  Sum-of-the-Years Digits, Modified Accelerated
  Cost Recovery System(MACRS)
• Tax implications of all methods

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• Use the information provided to make accrual
  adjustments.

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Figure 6-2 Adjustments to get accrual-adjusted
net farm income from a cash-basis income statement
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Capital Adjustments

• Made using cost basis of intermediate and long
  term assets
• Using market basis of assets includes valuation
  equity
• Valuation equity is change in asset values based
  on how the market value has increased or decreased

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Capital Adjustments

• Valuation Equity makes it hard to answer the
  following questions

Have you been doing a good job of managing the
value of your assets?
OR

• Has inflation of your assets made you look like a
  good manager?

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Cost vs. Market Basis of Assets

• Valuation equity a very good reason for making
  sure your balance sheets have BOTH columns
• Cost basis of assets generate good numbers for
  you to compare your farm with itself over several
  years
• Market basis of assets generates good numbers to
  compare your farm with peers for a single year

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ANALYSIS
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Farm Financial Standards Council

• Academics, bankers, CPAs, economists, farmers
• Designated 16 measures to assess farm financial
  health within following categories
• Liquidity
• Solvency
• Profitability
• Repayment Capacity
• Efficiency

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Farm Financial Standards Council Measures
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PROFITABILITY
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Net Cash Farm Income

• Total Cash Farm Income
• Total Cash Farm Expense

• Similar to 1040F Profit
• Missing only tax depreciation
• Often very different from Net Farm Income

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Net Farm Income(NFI)

• Total Cash Farm Income
• Total Cash Farm Expense
• /- Inventory Changes
• /- Depreciation and Capital Adjustments

• Return to farmer for unpaid operator labor,
  management, and equity
• What happens to NFI?
• Principal payments
• Owner withdrawals
• Capital purchases

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Net Farm Income per Unit(NFI/Unit)

• ( Total Cash Farm Income
• Total Cash Farm Expense
• /- Inventory Changes
• /- Depreciation and Capital Adjustments)
• ? Average Number of Units

• Units are some measure of farm inputs or outputs
• Acres, cows, cwt milk, bushels?
• Makes NFI somewhat comparable across farm sizes

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Net Farm Income per Unit(NFI/Unit)

• ( Total Cash Farm Income
• Total Cash Farm Expense
• /- Inventory Changes
• /- Depreciation and Capital Adjustments)
• ? Average Number of Units

• Units are some measure of farm inputs or outputs
• Acres, cows, cwt milk, bushels?
• Makes NFI somewhat comparable across farm sizes

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Rate of Return on Farm Assets (ROA)

• ( Net Farm Income
• Interest
• Value of Operator Labor Mgmt)
• ? Average Total Farm Assets

• Measures the before-tax rate earned by the of
  capital invested in the business

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Rate of Return on Farm Equity (ROE)

• ( Net Farm Income
• Value of Operator Labor Mgmt)
• ? Average Total Farm Equity

• Determines the before tax rate earned by the
  owners equity in the business
• If this value is higher than ROA, farm is
  efficiently utilizing borrowed capital

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EFFICIENCY
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Asset Turnover(ATO)

• Total Cash Farm Income
• ? Average Total Farm Assets

• Indicator of asset efficiency
• Dollars generated per dollar of assets

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Net Farm Income Percent(NFI)

• Net Farm Income
• ? Total Cash Farm Income

• Indicator of operating efficiency
• Indicates dollars kept for every dollar of
  revenue generated

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Trend Analysis

• Compares Balance Sheet Info across years
• Cost Basis
• Market Basis
• Some Cash Flow Info
• Nice place to look at values over time

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Analysis of Net Farm Income

• Rate of return on assets
• Rate of return on equity
• Operating profit margin ratio
• Return to labor and management
• Return to labor
• Return to management

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Adjusted Net Farm Income
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Opportunity Costs of Labor and Management
The opportunity cost of unpaid labor is the
estimated amount that any unpaid farm labor
could have earned elsewhere. The opportunity
cost of management is the estimated amount that
the operator could have earned for that
management time had it been used in paid work.
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Rate of Return on Assets(ROA)
Rate of return return to assets ()
average farm asset

? 100
on assets ()
value
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ROA for I.M. Farmer
51,300

? 100
ROA
725,750
7.07
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Return on Equity
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Rate of Return on Equity (ROE)
Rate of return return on equity ()
average equity ()

? 100
on equity ()
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ROE for I.M. Farmer
21,800

? 100
ROA
358,565
6.08
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Comparing ROA and ROE
If ROA gt i then ROE gt ROA If ROA lt i then ROE lt
ROA Where i is the interest rate on
borrowed capital. Thus, if ROA gt ROE borrowed
capital is earning, on average, less than the
interest rate. If ROA lt ROE, borrowed capital
is earning, on average, more than the interest
rate.
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Operating Profit
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Operating Profit Margin Ratio
operating profit

Operating profit margin ratio
? 100

total revenue
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Operating Profit Margin Ratio for I.M. Farmer
51,300
Operating profit margin ratio
? 100

200,400
25.6
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Opportunity Cost of Capital
To find the opportunity cost of capital, multiply
the opportunity interest rate (e.g. what the
capital could earn elsewhere) times the average
total asset value. For I.M. Farmer 725,7508
58,060
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Return to Labor and Management
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Return to Labor
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Return to Management
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Change in Owner Equity

• Retained farm earnings the part of farm
  earnings, after taxes and personal withdrawals,
  that is retained for use in the farm business
• A positive retained farm earnings increases owner
  equity
• If taxes and living expenses are greater than
  total earnings, owner equity will fall

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Figure 6-3Relation between net farm income and
change in equity
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Summary
An income statement organizes and summarizes
revenue and expenses for an accounting period.
Net farm income, or profit, is a dollar amount,
whereas profitability relates profits to the
size of the business.