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Your Net Income Statement

Learn how to calculate your farm's profitability through the Net Income Statement, which summarizes your income earned and expenses incurred over a period of time.

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Your Net Income Statement

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  1. Your Net Income Statement Gerry Schwab, Barbara Dartt, Sherrill Nott, Roger Betz and other FIRM AoE Team Members Day 2 -- morning Farm Financial Management

  2. Net Income Statement Purpose • Measures profitability through calculation of Net Farm Income (NFI) • Summarizes, for a period of time, the income earned and expenses incurred

  3. Net Income Statement Defined • Includes revenues and expenses • Does not include • principal payment • family draws • capital purchases • Does include • depreciation • change in inventory • change in AR & AP • Also known as Profit and Loss Statement

  4. Net Income Statement For: ___________________________ For time period: From _______ To _______ ***Income Statement*** Cash Farm Income Quantity Value Cash Farm Expense Inventory Changes Crop & Feed Market Receivables Prepaid Payables Total Livestock and other expenses & & accrued Income items Supplies Expenses Ending Inventory Beg. Beginning Inventory (-) -End (F) Inventory Change (=) (G)Net Operating profit (E+F) Depreciation and other Capital Adjustments Breeding Machinery Buildings & Other Livestock Equipment Improvements Assets Total Ending Inventory Capital Sales (+) Beginning Inventory (-) Capital purchases (-) (H) Depreciation/cap adj (=) (I) Net farm income (G+H)

  5. Building an Income Statement • NEED: • ALL Cash Income • ALL Cash Expenses • Plus Accurate Beginning and Ending Net Worth Statements to calculate changes in inventory

  6. Issues in Building an Income Statement • Identify clearly the person(s) or the business entity being described • Specify time period being described • Includes only income and expenses plus changes in inventory • Don’t confuse income with assets • Don’t confuse expenses with liabilities

  7. Financial Statement Linkages Historic Projected Dec. 31, 19X1 Dec. 31, 19X2 Dec. 31, 19X3 Balance Sheet 12/31/X1 Balance Sheet as of 12/31/X2 Statement of Owner Equity as of 12/31/X2 Pro Forma Balance Sheet as of 12/31/X3 (Flow Statement) Cash Flow Budget for 12 months ending 12/31/X3 Pro Forma Income Statement for 12 months ending 12/31/X3 Income Statement for 12 months ending 19X2 Statement of Cash Flows for 12 months ending 19X2 Source: Agricultural Financial Reporting & Analysis

  8. Net Farm Income PURPOSE: Indicator of Farm Business Profit earned during the accounting period • Unpaid family and operator labor • Unpaid management • Unpaid equity capital Net farm income is the RETURN TO: CALCULATION: • $ Gross farm income • Ending inventory of • Beginning inventory of • Ending inventory of accounts payable • Beginning inventory of accounts payable • Cash operating expenses Crops, feed market livestock, accounts receivable, and capital adjustments (depreciation)

  9. Net Farm Income % (NFI%) PURPOSE: Indicates profit performance of farm business and may suggest required business size for desired lifestyle withdrawals. Determines how much return for each dollar of sales. Can be used to compare individual farms to industry average, standard, or past performance. $ Net farm income  $ Gross farm income CALCULATION:

  10. Rate of Return on Farm Assets(or investment)(ROA or ROI) PURPOSE: To determine the before-tax rate earned by the $ of capital invested in the business. CALCULATION: $ Return on Farm Assets  $ Average Total Farm Assets

  11. Rate of Return on Farm Assets • Overall measure of profitability • Non-farm income should not be included • ROI Can vary with structure of business. (Owned land in business) • Market vs. cost method to value farm assets will affect ratio • Must consistently estimate the value of unpaid labor and management • Comparison across farms is more meaningful using market values • Comparison from year to year of an individual farm is more meaningful using cost values

  12. Rate of Return on Equity Capital(ROE) • PURPOSE: • To determine the Before-Tax Rate earned by the owner’s equity in the business. • If assets were valued at market value, this rate of return can be compared to ratios that could be earned in the market from alternative investments. CALCULATION: $ Net farm income - $ Opportunity Cost for: Unpaid labor and Management • $ Average Net Worth X 100 (to get on a percentage basis)

  13. Rate of Return on Farm Equity • Measures how well your equity capital is employed in the business • Highly leveraged and under capitalized farms can get wild results • Comparing across farms is more meaningful using market values • Deferred taxes should be included for return using market value -- will show low return without including deferred tax

  14. Value of Farm Production PURPOSE: To provide a measure of Gross Earnings Produced on farm + $ Gross Farm Income - $ Purchased Feed - $ Purchased Feeder Livestock  $ Changes in inventory of crops and feed, market livestock, accounts receivable, and breeding livestock CALCULATION:

  15. Asset Turnover Ratio PURPOSE: To measure how efficiently farm assets are being used to generate dollars of value-added production. High asset turnover ratio provides increased opportunity for profit. CALCULATION: • $ Value of Farm Production • $ Average Total Farm Assets

  16. Operating Profit Margin PURPOSE: To determine the operation efficiency of the business. It indicates the percent profit earned per dollar of value produced. CALCULATION: [($ Net Farm Income + $ Interest Expense - $ Opportunity Cost for unpaid labor and management)  $ Value of farm production] x 100

  17. % Return on Investment = Operating Profit Margin X Asset Turnover Rate

  18. If % ROA Is Not Satisfactory Must Increase 1. Operating Profit Margin and/or 2. Asset Turnover Rate

  19. Needs: Higher prices Lower overhead High yields Low operating expenses Change enterprise mix: to higher value crops e.g. specialty or value-added Pay Attention To: Marketing of output and output mix Investment & finance Production efficiency Purchasing of input and input mix External analysis of new business alternatives To Increase Operating Profit Margin

  20. To Increase Asset Turnover Ratio Needs: • Higher value of production • Value of invested assets is too high Pay Attention To: • Marketing of output and yield efficiency • Investment in durable assets • Alternative methods of asset control, e.g. renting, sharing, ownership, custom hire • Liquidate non-productive assets

  21. Term Debt and Capital Lease Coverage Ratio • PURPOSE: • Measures ability of the business to pay scheduled financial payments on term debts and capital leases. • If calculated ratio is less than one (100%), potential liquidity problems exist. • CALCULATION: +$ Net farm income • +$ Non-farm income* • +$ Interest on Term Debt • +$ Interest on Capital Lease • +$ Depreciation Expense • -$ Income and Social Security Tax* • -$ Owner withdrawals • $ Annual scheduled principal and interest payment on Term Debt and Capital Leases * In analyzing farm business only, you may prefer to exclude non-farm income. Also adjust downward the income tax obligations associated with the non-farm income.

  22. Capital Replacementand Term Debt Repayment Margin PURPOSE: To determine ability of the business to pay scheduled financial payment on term debts and capital leases. Indicates ability of business to generate funds for capital asset replacements. CALCULATION: + Capital replacement and term debt repayment capacity -$ Payment on unpaid operating debt from a previous period -$ Principal payment on current portion of term debt -$ Principal payment on current portion of capital lease

  23. Operating Expense Ratio PURPOSE: Indicates percentage of gross farm income that was spent for farm operating expenses; used for comparing expense control of the individual farm with the industry average. CALCULATION: ($ Total Farm Operating Expense - $ Farm Interest Expense)  $ Gross Farm Income

  24. Depreciation Expense Ratio PURPOSE: Can be used for comparing ownership expense on durable assets with industry average; provides indicator of amount of capitalization investment in depreciable assets. CALCULATION: $ Depreciation expense  $ Gross farm income

  25. Interest Expense Ratio • PURPOSE: • Indicates percentage of gross farm income spent on interest expense. • Can be used to compare individual farm to industry average, standard, or past performance. CALCULATION: • ($ Interest Expense • Change in Accrued Interest Expense) • $ Gross farm income

  26. Framework for Financial Analysis Cash Flow Balance Sheet Income Statement

  27. Framework for Financial Analysis Feasibility Risk-ability Solvency, Leverage, Capital Structure Liquidity, Repayment Capacity, Cash Flow Net Income, Financial Efficiency, Net Worth Growth Profitability

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