THE PROFITABILITY OF YOUR FARM BUSINESS
Now is a good
time for farm operators to take a good look at the financial performance
of their farm business for 2002. Most farm operators use a calendar
year (January 1 - December 31) as their business year for income
tax purposes and also to prepare financial statements about their
operation. Even if a business is on a different fiscal year for
tax reporting purposes, they may still want to prepare financial
statements based on a calendar year.
income statement is a more accurate measure of the profitability
of the farm business than the schedule F tax form. An accrual income
statement matches revenues with costs for a given time period, regardless
of when revenue was actually received or when expenses were actually
paid. For example, plow down fertilizer applied and paid for in
the fall of 2002 is considered a 2003 expense for business analysis
purposes even though it will be taken as an expense on the 2002
income tax return for a cash basis tax payer. This is because it
will be utilized for the 2003 crop.
accrual income, adjustments are made to cash income and expenses
for changes in values between the beginning and end of the year
for grain and livestock inventories, accounts receivable, accounts
payable and prepaid expenses. Depreciation on machinery and buildings
is also subtracted off. If the accounting system a producer is using
does not generate an accrual income statement, the schedule F tax
form along with the beginning and end of year balance sheet can
be used to calculate accrual income. To cover a 12-month period,
the balance sheet should be completed as of the same date every
year, preferably December 31.
in certain areas of Illinois last year illustrate the importance
of measuring income based on an accrual measure rather than a cash
basis. To illustrate this, we will use Joe Farmer's information
that is given in Figure 1. Joe Farmer is a cash basis farmer that
sells most of his crop in the year after production. He experienced
low yields in 2002 resulting from dry weather conditions. He also
plans on receiving crop insurance payments, but not until 2003.
He has been prepaying some expenses but paid less at the end of
2002 than in previous years. He is also expecting an additional
government payment for the 2002 crop year when he signs up for the
program in 2003.
grain sales and other farm income in 2002 were $261,179. Most of
this was grain produced in 2001 and sold in 2002. One of the accrual
adjustments that is made in calculating gross returns is the difference
between the beginning and ending grain inventory value. Due to the
dry weather conditions and
resulting lower yields, the value of Joe's inventory on December
31, 2002 was $121,690. His beginning of year grain inventory value
was $212,750. He therefore had a decline in inventory value of $91,060.
Joe is expecting
to receive $42,300 in crop insurance proceeds for crop loss to his
2002 crop. He will not receive this until 2003. He is also expecting
to receive another $15,100 in government direct payments for the
2002 crop year when he signs up for the new farm program. This also
will not be received until 2003.
based gross farm returns is calculated by taking his grain sales
and other farm income of $261,179, subtracting off the $91,060 decrease
in inventory value and adding back his increase in accounts receivable
of $42,300 in crop insurance payments and $15,100 in government
farm program payments. His gross farm returns for 2002 is $227,519.
operating expenses and deprecation total $221,650. To get to an
accrual based figure, adjustments to the cash expenses are made
for changes in accounts payable and prepaid expenses. Joe paid for
$34,100 of nitrogen fertilizer in 2001 for the 2002 crop. He paid
for only $6,500 of nitrogen fertilizer in 2002 for his 2003 crop.
The difference of $27,600 is added to his cash operating expenses
in determining total accrual expenses for 2002. Joe's interest due
at the end of the year on borrowed money was $12,100 compared to
only $4,200 at the beginning of the year. Since his interest due
was larger at the end of the year, the difference of $7,900 is added
to his cash operating expenses in determining total expenses for
the year. Joe's total operating expenses for 2002, after the accrual
adjustments are made, is $257,150.
income of $39,529 on his 2002 schedule F. This was arrived at by
subtracting his cash operating and depreciation expenses of $221,650
from his grain sales and other income of $261,179. However, after
adjusting his net cash income for changes in inventory values, accounts
receivables, prepaid expenses and accounts payable, his accrual
net farm income was actually a negative $29,631. So while Joe thought
he made about $40,000, he actually lost about $30,000, a $70,000
income statement combined with a balance sheet are two key financial
statements to analyze the farm business. With the completion of
these statements, key financial ratios and other analysis can be
completed to measure the direction the farm business is going financially.
analysis tools which will help you complete an accrual income statement
and balance sheet can be found at the University of Illinois farmdoc
Dale Lattz, Department
of Agricultural and Consumer Economics