Farm Income Statement Analysis

Farm Income Statement Analysis - Farm Income Statement...

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Farm Income Statement Analysis AAE 320 Paul D. Mitchell Goal Overview accounting income statement as it pertains to agricultural operations How to prepare and/or read one How to use one (rates of return) Income Statement Income Statement: Record of revenues and expenses over a period of time Balance Sheet: Statement of assets, liabilities and equity at a point in time Other names for an income statement Operating Statement Business/Farm Profit and Loss Statement Question: Did you make money last year? Revenue Account for all business revenue earned during the period: cash and non-cash Crop sales Feeder livestock sales Crop and Livestock product sales Government program payments, including crop insurance and disaster payments Anything you sell! Non-Cash Revenue Inventories changes for commodities ready for sale Grain, feeder livestock Accrual basis: value of ending inventory minus value of beginning inventory Accounts receivable: ending balance minus beginning balance Non-cash payments in kind, trades, custom harvest arrangements, etc. Revenue: Special Cases Gain/Loss from sale of culled breeding livestock or milk cows Normal part of production process, not treat as gain/loss from sale of a capital asset Change in value of raised breeding livestock or milk cows Treat increase in value of a raised heifer calf becoming a cow or milk cow (or part way along this process) as an increase in revenue Revenue: Special Cases Gains or Losses on Sales of Capital Assets are treated as revenue Land: Selling Price minus Cost Only change due to price changes Depreciable Assets: Selling Price minus Book Value (Book value is value according to your depreciation schedule) Changes due to price changes and errors in estimating depreciation This adjusts revenue for errors in depreciation, which are very common Expenses Account for all business expenses incurred during the period: cash and non-cash Purchased inputs: fertilizer, seed, fuel, chemicals, feeder livestock, feed, etc. Labor and services Repairs and maintenance Property taxes, insurance, etc. Everything you buy for the farm!!! Non-Cash Expenses Depreciation All capital assets (buildings, tractors, etc.) Breeding livestock, milk cows, perennial crops Cost of production to account for, even if you don't pay cash Ending accounts payable balance minus beginning accounts payable balance Accounts Payable: Prepaid Expenses Expenses from previous period for production during this period Common examples: fertilizer, seed, feed etc. bought in previous year for this year Pay this year for prepaid expenses you paid last year for use this year Put off to next year prepaid expense you paid this year for use next year Expenses for This Year = Prepaid Expense Last Year Prepaid Expense This Year Accrued Expenses Cash interest paid Add accrued interest owed Subtract interest prepaid Add accrued taxes owed Subtract taxes prepaid Should estimate, but that very difficult Do Income Statement as pre-tax income Do after-tax Income Statement later after pay taxes Property taxes paid Income taxes Income Statement General format given here, are many variations in use Main Idea Revenue Expenses = Net Farm Income from Operations Add gain/loss net gain from sale of capital assets = Net Farm Income Some like to keep interest payments separate so can see income from production activities vs financing activities Accrual Adjustment of Cash Basis Income Statement Not everyone does accrual accounting (the business standard)--cash accounting still the most common Accrual accounting more accurate/useful for decision making--puts costs in year used and receive accompanying revenue, but more complex and time consuming Cash accounting simple and has advantages for income tax purposes, so more popular Cash accounting can be misleading, so recommend those using cash accounting to develop an accrual adjusted net farm income Accrual Adjusted Net Farm Income Cash Net Income (pre-tax) = Cash Receipts Cash Disbursements Depreciation Gain/Loss Capital Sale Accrual adjustments to Cash Receipts Adjust for Inventory Changes (e.g., grain and feeder livestock) Cash Receipts + Value of Ending Inventory Value of Beginning Inventory = Gross Revenues Accrual Adjusted Cash Disbursements to get Operating Expenses Many more accrual adjustments of cash disbursements to generate operating expenses Goal: to get costs accounted for in the year they were used to produce revenue, not the year they actually spent Accounts Payable, Prepaid Expenses, Unused Supplies, Accrued Expenses Accrual Adjusted Cash Disbursements Cash Disbursements + Ending Accounts Payable Beginning Accounts Payable + Ending Accrued Expenses Beginning Accrued Expenses Ending Prepaid Expenses + Beginning Prepaid Expenses Ending Unused Supplies (fuel, chems, seed, fert) + Beginning Unused Supplies (fuel, chems, seed, fert) = Operating Expenses Accrual Adjusted Net Farm Income Cash Net Income (pre-tax) = Cash Receipts Cash Disbursements Depreciation Gain/Loss Capital Sale Accrual Adjusted Net Income (pre-tax) = Gross Revenues Operating Expenses Depreciation Gain/Loss Capital Sale Main point: use accrual adjustments to cash receipts and disbursements Main Point Most farmers use cash accounting, commonly to file tax forms Farmers commonly move costs between years to reduce taxes Income statements adjust this tax income for more accurate measurement of income Pay for costs in the year actually used, not in tax year the cost deducted from taxable income Example to illustrate If 2004 a good year, pre-buy more inputs (fertilizer, seed) in 2004 for use in 2005 to lower 2004 taxes Same trick with accounts payable in 2004: payoff in 2004 to reduce 2004 taxes, not wait until 2005 to pay off Income statement: adjust for these practices: Pay for costs in year used to make income, even if actually bought in different year: How? Ending Prepaid Expenses + Beginning Prepaid Expenses + Ending Accounts Payable Beginning Accounts Payable Main Point Summary How adjust tax income for more accurate income statement Adjust cash receipts for inventory changes Adjust cash disbursements for accounts payable, accrued expenses, prepaid expenses, and input inventory changes Uses for Income Statement See if made a business profit or had a loss, but really want to know profitability Profitability: normalize for size to see if efficient use of resources to produce income Four Measures commonly used Net Farm Income Rate of Return on Assets Rate of Return on Equity Operating Profit Ratio Net Farm Income We already did this one--it's what the income statement produces!!! This income covers your Unpaid Labor (yours and your family's) Management time and effort (yours and your family's) Return on your equity Will remove value of Unpaid Labor and Management from Net Farm Income to calculate the other measures Rate of Return on Assets Use net far income to estimate the rate of return on assets Also called Return to Capital, Return on Investment Need to adjust farm income for reasons to be explained Use Balance Sheet to find the average assets during the accounting period This why Farm Balance Sheet and Income Statement go together Rate of Return on Assets Want return on all assets, those financed with debt and with equity, so need to add interest expenses back into farm income Not include gain/loss from sale of capital assets, as this not a source of returns due to productivity (but errors in depreciation) Not include unpaid labor and management so need to remove these from net farm income: How? Often use opportunity cost Rate of Return on Assets Rate of Return on Assets = (Return on Assets / Average Assets) x 100 Return on Assets = Net Farm Income from Income Statement with adjustments 1) Add Interest Expenses back in 2) Subtract (or do not include) Gain/Loss from Sale of Capital Assets 3) Subtract opportunity cost of unpaid Labor and Management time and effort Net Farm Income from Operations is what's left after the 1st and 2nd adjustment Return on Assets Remember Net Farm Income from Income Statement: everything left had to cover Unpaid Labor and Management time and effort or you and your family, plus Return on your equity For Return on Assets: need to estimate the costs for unpaid Labor and Management time What it would cost to hire someone to do all the currently unpaid labor and management? You and family are worth as much as you could make at your next best alternatives, i.e., your opportunity costs Return on Assets Main point: It's easy to add Interest Expenses back in and not include Gain/Loss from Sale of Capital Assets Removing costs of labor and management are somewhat arbitrary, but important What ever costs you choose will change your estimated Return on Assets Many just use Net Farm Income from Operations and ignore unpaid labor and management Know these issues before you compare with other businesses and with market returns Rate of Return on Assets Rate of Return on Assets = (Return on Assets / Average Assets) x 100 We talked lots about the Numerator! Denominator: Average Assets = average assets during the accounting period Usually use average of beginning and ending Balance Sheet total assets Which basis for asset valuation: cost or market? Usually market basis so can compare farms and compare to liquidating and getting market rates Cost basis to look at your trend over years FFSC recommendations/caveats 1) Use net farm income from operations (no gain/loss from capital assets sales) 2) Opportunity costs for labor and management are estimates, different costs give different answers 3) Comparing rates of return only if done in same way, especially asset valuation 4) Do not include non-farm assets and income 5) This estimates the average rate of return (over all $ invested), not the marginal rate of return (on the last $ invested): not proper to use when deciding investment in additional farm assets Market basis to compare farms Cost basis to see your trends over time Final Comment on Return on Assets Probably the most difficult part is subtracting opportunity costs for unpaid labor and time Hard to estimate If you don't subtract them, then you get a higher rate of return on assets and bragging rights Better to include these costs and think, After I pay myself (and my family), what rate of return do I earn on the assets (and my equity)? Can use Return on Assets to calculate return on equity and profit margin, so do it right Rate of Return on Equity Just like rate of return on assets, except now you do not include the interest costs, since this was the farm income used to pay for debt equity Rate of Return on Equity = (Return on Equity / Average Equity) x 100 Average Equity = average of equity at the beginning and end of the period, as obtained from the farm Balance Sheet Return on Equity Return on Equity = Net Farm Income from Income Statement with adjustments 1) Subtract (or do not include) Gain/Loss from Sale of Capital Assets 2) Subtract opportunity cost of unpaid Labor and Management time and effort Alternative 1: Return on Assets Interest Expenses Alternative 2: Net Farm Income from Operations Interest Expenses Opportunity Cost of Labor and Management Return on Equity and Assets Only difference between return on equity and return on assets is interest expenses Interest expenses depend on the interest rate If Rate of Return on Assets > Interest Rate, Rate of Return on Equity > Rate of Return on Assets If Rate of Return on Assets < Interest Rate, Rate of Return on Equity < Rate of Return on Assets Main point: if rate of return on assets exceeds the interest rate (benefit exceeding the cost), then the extra margin generated from use of external funds goes to increase rate of return on equity Operating Profit Margin Ratio (or Simply Profit Margin) Operating profit as percent of revenue Operating profit = Return on Assets Operating Profit Margin Ratio = Operating Profit / Total Revenue = Return on Assets / Total Revenue Low Profit Margin: improve ratio first (by lowering costs) before expansion High Profit Margin: expansion may make sense Summary How to develop an Income Statement Accrual Accounting Accrual Adjusted Cash Accounting Net Farm Income Rate of Return on Assets Rate of Return on Equity Profit Margin Measures from Income Statement Look at example rates and margins Look at example income statement Rates of Return in Dairy Rate of Return on Assets = ROROA Rate of Return on Equity = ROROE UW Center for Dairy Profitability Two methods Assets at Cost and use Tax Depreciation Assets at Market Value and use Economic Depreciation Does not include cost of unpaid labor and management or opportunity cost of owner equity http://cdp.wisc.edu/pdf/02bench.pdf Average Profitability in WI Dairy Cost and Tax Depreciation 2002 2001 2000 ROROA ROROE 4.00% -1.69% 10.01% 16.15% 7.91% 9.07% Profit Margin 4.99% 12.38% 10.25% Market Value and Economic Depreciation 2002 ROROA ROROE 2.17% 0.05% 2001 5.65% 4.82% 2000 4.24% 2.34% Profit Margin 5.79% 13.31% 10.52% ROROA in WI Dairy Year ROROA* 1995 5.57% 2002 Range of ROROA Range < 0% 0% - 2.5% % Farms 35.5% 20.1% 1996 1997 1998 1999 2000 2001 2002 5.36% 5.42% 9.20% 7.56% 4.24% 5.65% 2.17% 2.5% - 5% 5% - 7.5% 16.3% 14.0% 7.5% - 10% > 10% 7.1% 7.1% * Assets at Market Value and Economic Depreciation Other States and Farm Types Illinois 2004 ROROA and ROROE Grain 6.2% 7.1% Hog 13.4% 19.2% Beef 2.9% 2.6% Dairy 9.6% 11.2% MN Farm Bus. Mngmt. Assoc. 2004 8.0% 10.9% 17.6% profit margin Range: Lowest 20% farms: -2.7%, -18.0%, -8.0% Highest 20% farms: 13.4%, 20.8%, 26.0% Other States and Farm Types Iowa 1990-1998 average ROROA ROROE Grain 7.3% 6.0% Hog 7.4% 6.3% Fed Beef 6.0% 4.6% Cow-Calf 4.5% 2.6% Dairy 7.6% 7.5% Margin 22.3% 20.9% 23.1% 16.0% 21.1% Other States and Farm Types Iowa 1990-1998 average ROROA ROROE All owned 5.6% 4.4% Own/Rent 6.8% 6.5% Cash Rent 7.8% 7.4% Crop Share 9.5% 9.9% Lstock Share 6.4% 4.5% Margin 20.7% 23.3% 14.2% 18.9% 17.2% Example from FFSC Publication Farm Financial Standards Council (FFSC) has large publication (200+ pages) explaining farm financial statements, with an appendix of extended examples Web link: http://www.ffsc.org/guidelin.htm Posted copy on class homepage Will go through handout in class Balance Sheet Example from FFSC 20X2 Current Assets 322,014 765,900 1,087,914 20X1 Current 300,203 Liabilities 20X2 246,712 349,623 596,335 20X1 225,917 365,405 591,322 Non-Current Assets Total Assets Non-Current 763,900 Liabilities Total 1,064,103 Liabilities Equity Current Ratio 1.31 1.33 491,579 472,781 Debt to Asset Equity to Asset 0.55 0.45 0.56 0.44 Debt to Equity 1.21 1.25 Income Statement Example from FFSC Gross Revenues Operating Expenses Interest Expenses Net Income From Operations Miscellaneous Revenue Total Taxes Net Income Unpaid Labor & Management Return on Assets Return to Equity ROROA ROROE Profit Margin 304,699 From sheet 221,556 From sheet 29,577 From sheet 53,566 Do the math! 150 From sheet 34,940 From sheets 18,776 Do the math! 29,620 From sheet 18,733 Income + Interest Unpaid Labor (10,844) Return on Assets Interest 1.7% Use Balance Sheet -2.2% Use Balance Sheet 6.1% Return on Assets/Gross Rev. Income Statement Example from FFSC Gross Revenues Operating Expenses 304,699 221,556 Interest Expenses Net Income From Operations Miscellaneous Revenue 29,577 53,566 150 Total Taxes Net Income 34,940 18,776 Unpaid Labor Management Return on Assets Return to Equity 29,620 18,733 (10,844) Before Income Taxes 53,673 24,096 ROROA ROROE 1.7% -2.2% 5.0% 5.0% Profit Margin 6.1% 17.6% Farm Accounting Programs (from Jenny Vanderlin, UW CDP) AAIMS: Agricultral Accounting and Management Information System UW CDP developed and CDP, UWEX supports, cheap ($150) for dairy only General farm accounting, Badgerland FCS More expensive, used by ag accounting firms CenterPoint is newer, more for farmers AgManager by AgriSolutions Redwing sells CenterPoint and Perception Farm Accounting Programs (from Jenny Vanderlin, UW CDP) Several Others: Farm Fund$, PeachTree, QuickBooks, Quicken, MoneyWorks CDP and UIWEX do presentations and workshops for farmers to learn more about these Heart of the Farm, Annie's Project UWEX as requested WI Farm Management Associations Fox Valley Farm Management Appleton, WI (920) 993-1366 Lakeshore Farm Management http://www.lakeshorefarmmanagement.com/ Valders, WI (920) 775-3900 http://www.farmcredit.com/ Farm Credit Services GreenStone (Appleton) (920) 739-3186 Badgerland (Baraboo) (608) 356-4903 North Central Wisconsin (Wausau) (715) 842-4631 AgStar Financial Services (Mankato, MN) UWEX County Agents More Information Web pages I gave with Balance Sheets UWEX Center for Dairy Profitability FarmDOC IL Extension Center for Farm Financial Management MN EX AgDecision Maker IA Extension Damona Doye at Oklahoma State University Farm Financial Standards Council Agriculture Financial Advisor (AgFA) by CDP and UWEX Other states have comparable groups ...
View Full Document

This note was uploaded on 08/08/2008 for the course AAE 320 taught by Professor Mitchell during the Spring '08 term at Wisconsin.

Ask a homework question - tutors are online