Gauging the Farm's Financial Success
Tax returns are generally a poor way to assess financial performance.
Farm income set records in 2011, with estimated total net income for U.S. farms topping $100 billion, according to USDA economic forecasts. With tax season approaching, this is a good time for individual farmers to take a good look at their own operations' financial performance, says a University of Missouri (MU) Extension agriculture business specialist.
"While many farmers rely on their Schedule F from their tax returns to assess their profitability, tax returns are generally a poor way to assess financial performance," says Whitney Wiegel.
"Because most farmers record income on a cash basis for their taxes, their Schedule F statements do not show amounts for year-to-year changes in inventory, accounts payable or accounts receivable," he said.
Cash income and expenses for a production cycle are not always realized in the matching operating or recordkeeping year, so cash-based income statements often don't provide an accurate assessment of farm income for a given time period, he said.
For example, according to a cash-income statement, an operation might appear healthy because lots of money is flowing in as past customers pay their bills, yet that operation might actually be in real trouble if recent sales are down sharply and expenses are rising.
"To accurately assess farm income for a given year, an accrual-based or accrual-adjusted income statement should be generated," Wiegel said.
Under accrual-based accounting, you record income and expenses when goods or services are exchanged, not when the bill is paid. An accrual income statement, therefore, reflects money you have earned even if it hasn't landed in your checking account yet. Likewise, it records expenses you have incurred even if you haven't paid for them yet.
"The purpose of an accrual income statement is to match income and expenses to the production year for which they were earned or expended," Wiegel said.
Accrual income statements are superior to cash income statements, but they do require farmers to record more information, he noted.
"If a farmer uses a cash-based recordkeeping system, the best way to record and find this information is to generate or update a farm balance sheet at the end of each year," he said.
The balance sheet is a snapshot of the farm's financial position. It includes an inventory of the farm's assets and liabilities. Assets include cash, accounts receivable and inventory, as well as fixed assets such as land, buildings and equipment. Liabilities include accounts payable, salaries, taxes, insurance and long-term debt.
By matching the date of the farm balance sheet to the ending date of the fiscal or tax year, farmers can generate accurate accrual-based income statements.
To generate accrual income statements for a given year, farmers who use a cash accounting system would first calculate their net cash farm income for the year. Then, using the information recorded on the beginning- and end-of-year balance sheets, they can adjust the net cash farm income to reflect the changes they observed on the balance sheets.
"The result is an accrual-adjusted income statement that gauges the financial performance of the farm for a given year," Wiegel said.
For more information about how to generate accurate financial statements, including income statements and balance sheets, contact your local MU Extension center.
Additional resources, including a short online course on financial statements, are available from the University of Minnesota's Center for Farm Financial Management at http://ifsam.cffm.umn.edu/.
