Farm Management

1
Farm Management

• Chapter 6
• The Income Statement
• and Its Analysis

2
Chapter Outline

• Identifying Revenue and Expenses
• Income Statement Format
• Accrual Adjustments to a Cash-Basis Income
  Statement
• Analysis of Net Farm Income
• Change in Owner Equity
• Summary

3
Chapter Objectives

1. To discuss the purpose and use of an income
   statement
2. To illustrate the structure and format of an
   income statement
3. To define the sources and types of revenue and
   expenses included
4. To show how net farm income is computed and what
   it means
5. To analyze farm profitability

4
What is an Income Statement?
An income statement is a summary of revenues and
expenses as recorded over a period of time.
5
Figure 6-1 Relation between balance sheet and
income statement
6
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

7
Income Statement Format
Total revenue Less total expenses Equals net farm
income from operations Plus or minus gain/loss on
sale of capital assets Equals net farm income
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Table 6-1 Income Statement Format
9
Accrual Adjustments to a Cash-Basis Income
Statement

• The FFSC recommends that anyone using cash
  accounting convert the resulting net farm income
  to an accrual-adjusted net farm income at the end
  of each year
• Two adjustments to cash receipts change in
  inventory values and accounts receivable
• Several adjustments to expenses, including
  accounts payable and accrued expenses

10
Figure 6-2 Adjustments to get accrual-adjusted
net farm income from a cash-basis income statement
11
Table 6-2 Income Statement for I.M. Farmer for
Year Ending December 31, 20003
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Net Farm Income
Net farm income is the amount by which revenue
exceeds expenses, plus any gain or loss on the
sale of capital items. It represents the
return to the operator for unpaid
labor, management, and equity capital. Net farm
income from operations excludes gain or loss on
sale of capital items.
13
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

14
Adjusted Net Farm Income
15
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.
16
Return to Assets
17
Rate of Return on Assets(ROA)
Rate of return return to assets ()
average farm asset

? 100
on assets ()
value
18
ROA for I.M. Farmer
51,300

? 100
ROA
725,750
7.07
19
Return on Equity
20
Rate of Return on Equity (ROE)
Rate of return return on equity ()
average equity ()

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

? 100
ROA
358,565
6.08
22
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
24
Operating Profit Margin Ratio
operating profit

Operating profit margin ratio
? 100

total revenue
25
Operating Profit Margin Ratio for I.M. Farmer
51,300
Operating profit margin ratio
? 100

200,400
25.6
26
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
28
Return to Labor
29
Return to Management
30
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

31
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.