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Farm Management. Chapter 6 The Income Statement and Its Analysis. What is an Income Statement?. An income statement is a summary of revenues and expenses as recorded over a period of time. Figure 6-1 Relation between balance sheet and income statement.

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Farm management

Farm Management

Chapter 6

The Income Statement

and Its Analysis


What is an income statement
What is an Income Statement?

An income statement is a summary of

revenues and expenses as recorded

over a period of time.


Figure 6 1 relation between balance sheet and income statement
Figure 6-1 Relation between balance sheet and income statement


Identifying revenue and expenses
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


Net income statement defined
Net Income Statement, defined

  • Includes Revenues and Expenses

  • Revenues – Expenses =

    NET FARM INCOME (NFI)

  • Net Farm Income = Profit

  • Also known as a Profit & Loss Statement


Inventory changes
Inventory Changes

  • Crops and Feed on Hand

  • Market Livestock

  • Accounts Receivable

  • Prepaid Expenses

  • Accounts Payable

  • Does this sound familiar??

CURRENT ASSETS on

the BALANCE SHEET


Inventory changes1

Ending Inventory

- Beginning Inventory

= Inventory Change

Inventory Changes

  • Current Assets have a life of < 1 yr

  • Balancing inventories accounts for the changes in these assets

*Accounts Payable: Beg Inv – End Inv = Inv Change


Depreciation and capital adjustments
Depreciation and Capital Adjustments

  • Breeding Livestock

  • Machinery & Equipment

  • Buildings and Improvements

  • Other Assets

  • Does this sound familiar??

INT and LT ASSETS on

the BALANCE SHEET


Depreciation and capital adjustments1

Ending Inventory

+ Capital Sales

  • - Beginning Inventory

  • - Capital Purchases

  • = Depreciation / Capital Adjustments

Depreciation and Capital Adjustments

  • Intermediate and Long Term Assets last > 1 yr

  • Depreciation calculates amount of asset “used up” during the last year


Depreciation
Depreciation

  • How much of the asset is “used up” during the year?

  • Lots of methods to calculate:

    • Straight line

      • Asset Value (cost basis)  Years of Life

    • Declining balance, Double-declining balance, Sum-of-the-Years Digits, Modified Accelerated Cost Recovery System(MACRS)

    • Tax implications of all methods



Figure 6 2 adjustments to get accrual adjusted net farm income from a cash basis income statement
Figure 6-2 Adjustments to get accrual-adjusted net farm income from a cash-basis income statement


Capital adjustments
Capital Adjustments

  • Made using cost basis of intermediate and long term assets

  • Using market basis of assets includes “valuation equity”

    • Valuation equity is change in asset values based on how the market value has increased or decreased


Capital adjustments1
Capital Adjustments

  • Valuation Equity makes it hard to answer the following questions:

Has inflation of your assets made you look like a good manager?

Have you been doing a good job of managing the value of your assets?

OR


Cost vs market basis of assets
Cost vs. Market Basis of Assets

  • Valuation equity a very good reason for making sure your balance sheets have BOTH columns

  • Cost basis of assets generate good numbers for you to compare your farm with itself over several years

  • Market basis of assets generates good numbers to compare your farm with “peers” for a single year



Farm financial standards council
Farm Financial Standards Council

  • Academics, bankers, CPAs, economists, farmers

  • Designated 16 measures to assess farm financial health within following categories:

    • Liquidity

    • Solvency

    • Profitability

    • Repayment Capacity

    • Efficiency


Farm financial standards council measures
Farm Financial Standards Council Measures



Net cash farm income
Net Cash Farm Income

Total Cash Farm Income

– Total Cash Farm Expense

  • Similar to 1040F “Profit”

    • Missing only tax depreciation

  • Often very different from Net Farm Income


Net farm income nfi
Net Farm Income(NFI)

Total Cash Farm Income

– Total Cash Farm Expense

+/- Inventory Changes

+/-Depreciation and Capital Adjustments

  • Return to farmer for unpaid operator labor, management, and equity

  • What happens to NFI?

    • Principal payments

    • Owner withdrawals

    • Capital purchases


Net farm income per unit nfi unit
Net Farm Income per Unit(NFI/Unit)

( Total Cash Farm Income

– Total Cash Farm Expense

+/- Inventory Changes

+/-Depreciation and Capital Adjustments)

 Average Number of Units

  • Units are some measure of farm inputs or outputs

    • Acres, cows, cwt milk, bushels?

  • Makes NFI somewhat comparable across farm sizes


Net farm income per unit nfi unit1
Net Farm Income per Unit(NFI/Unit)

( Total Cash Farm Income

– Total Cash Farm Expense

+/- Inventory Changes

+/-Depreciation and Capital Adjustments)

 Average Number of Units

  • Units are some measure of farm inputs or outputs

    • Acres, cows, cwt milk, bushels?

  • Makes NFI somewhat comparable across farm sizes


Rate of return on farm assets roa
Rate of Return on Farm Assets (ROA)

  • Measures the before-tax rate earned by the $ of capital invested in the business

( Net Farm Income

+ Interest

– Value of Operator Labor & Mgmt)

 Average Total Farm Assets


Rate of return on farm equity roe
Rate of Return on Farm Equity (ROE)

( Net Farm Income

– Value of Operator Labor & Mgmt)

 Average Total Farm Equity

  • Determines the before tax rate earned by the owner’s equity in the business

  • If this value is higher than ROA, farm is efficiently utilizing borrowed capital



Asset turnover ato
Asset Turnover(ATO)

  • Indicator of asset efficiency

  • Dollars generated per dollar of assets

Total Cash Farm Income

 Average Total Farm Assets


Net farm income percent nfi
Net Farm Income Percent(NFI%)

Net Farm Income

 Total Cash Farm Income

  • Indicator of operating efficiency

  • Indicates dollars kept for every dollar of revenue generated


Trend analysis
Trend Analysis

  • Compares Balance Sheet Info across years

    • Cost Basis

    • Market Basis

    • Some Cash Flow Info

  • Nice place to look at values over time


Analysis of net farm income
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



Opportunity costs of labor and management
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.


Rate of return on assets roa
Rate of Return on Assets(ROA)

Rate of return return to assets ($)

average farm asset

=

 100%

on assets (%)

value


Roa for i m farmer
ROA for I.M. Farmer

$ 51,300

=

 100%

ROA

$725,750

= 7.07%



Rate of return on equity roe
Rate of Return on Equity (ROE)

Rate of return return on equity ($)

average equity ($)

=

 100%

on equity (%)


Roe for i m farmer
ROE for I.M. Farmer

$ 21,800

=

 100%

ROA

$358,565

= 6.08%


Comparing roa and roe
Comparing ROA and ROE

If ROA > i then ROE > ROA

If ROA < i then ROE < ROA

Wherei is the interest rate on borrowed

capital. Thus, if ROA > ROE borrowed

capital is earning, on average, less than

the interest rate. If ROA < ROE,

borrowed capital is earning, on average,

more than the interest rate.



Operating profit margin ratio
Operating Profit Margin Ratio

operating profit

Operating profit margin ratio

 100%

=

total revenue


Operating profit margin ratio for i m farmer
Operating Profit Margin Ratio for I.M. Farmer

$ 51,300

Operating profit margin ratio

 100%

=

$200,400

= 25.6%


Opportunity cost of capital
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: $725,750×8% = $58,060





Change in owner equity
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


Figure 6 3 relation between net farm income and change in equity
Figure 6-3Relation between net farm income and change in equity


Summary
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.