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 to calculate rates of return
Income Statement
Income Statement: Record of revenues and
expenses over a period of time
Remember: Balance Sheet is statement of
assets, liabilities and equity at a point in time
Other names for an income statement
Operating Statement
Profit and Loss Statement (P and L)
Income = Revenue minus Costs
Question it answers:
Did you make money last year?
Income Statement
Income = Revenue minus Costs
Revenue consists of Cash Revenue and Non-
Cash Revenue
Costs consist of Cash Costs and Non-Cash Costs
Cash Revenue
Account for all business revenue earned during
the period: cash and non-cash
Cash Revenue
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

Inventory 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
Miscellaneous: Non-cash payments in kind,
trades, custom harvest arrangements, etc.
Revenue: Special Cases
Gain/Loss from sale of culled breeding livestock
or milk cows
Treat as Cash Revenue
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
Kind of like an inventory change
Revenue: Special Cases
Gains or Losses on Sales of Capital Assets are
treated as revenue
Land: Selling Price minus Selling Costs
Revenue changes only due to price changes
Selling costs: often there are deferred taxes due
Depreciable Assets: Selling Price minus Book
Value (Book value is value according to your
depreciation schedule)
Revenue changes due to price changes and
errors in estimating depreciation
This adjusts revenue for errors in depreciation,
which are very common
Cash 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
dont pay cash
Accounts Payable
Ending accounts payable balance minus
beginning accounts payable balance
Prepaid Expenses
Expenses from previous period for production
during this period
Common examples: fertilizer, seed, feed etc.
bought in previous tax year for this crop 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
Main idea: put expenses into the crop year the
purchased inputs are used
Accrued Expenses
Cash interest paid
Add accrued interest owed
Subtract interest prepaid
Property taxes paid
Add accrued taxes owed
Subtract taxes prepaid
Income taxes owed
Should estimate, but that very difficult
Do Income Statement as pre-tax income
Do after-tax Income Statement later after pay taxes
Income Statement
General format given here, 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
Keep interest payments separate so can
see income from production activities vs
investment activities
Accrual Adjustment of Cash Basis Income
Statement

Most farmers do not use accrual accounting (the

business standard: GAAP): 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
Accrual adjusted NFI is technically the correct
way to do an income statement
Farm accountants will work out the details
Main goal: trying to get revenue and costs into
the period of the correct income statement
Many technical accounting rules to make thee
accrual adjustments, but most let the accountants
deal with the details
Main Point
Most farmers use cash accounting, commonly to
file tax forms
Farmers commonly move costs between years to
reduce taxes
Accrual Adjusted Income Statements adjust this
tax income for more accurate income measure
Put revenue and costs in the year actually
intended for, not in the year used for taxes
Simple Example to Illustrate Cash versus Accrual
Accounting
If 2013 a good year, pre-buy more inputs (fertilizer,
seed) in 2013 for use in 2014 to lower 2013 taxes
Same trick with accounts payable in 2013: payoff
in 2013 to reduce 2013 taxes, not wait until 2014
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
Five Measures commonly used
Net Farm Income from Operations
Should be Accrual
Net Farm Income
Adjusted
Rate of Return on Assets
Rate of Return on Equity
Operating Profit Ratio
Calculating Farm Income: Revenue

You decide what non-cash sources to include and

whether its accrual adjusted or not
1) Selling things: self explanatory
2) Capital Gains: Selling of capital (non-current)
assets for prices different than their basis
Sell land for different price than original cost
Depreciable assets: selling for price different
than remaining basis
Calculating Farm Income: Cost
1) Operating Costs: You decide what non-cash
costs to include and whether to use accrual
adjustments
2) Interest: separate it out as operating expense
Need to account for interest in some measures
3) Unpaid Labor and Management: how much
you pay yourself for labor and management
Need to account for in some measures
Net Farm Income from Operations (NFIfO)
NFIfO = Revenue Operating Costs Interest
NFIfO = Income made by farm operation
Does not include investment income from capital
asset sales: depreciation should already be
included as a non-cash expense
Does not include paying the operator/manager for
time and labor
Net Farm Income (NFI)
NFI = Revenue Operating Costs Interest
Unpaid Labor & Management + Capital Gains
Income generated by farm business after paying
all expenses (operation & investment activities)
Includes net gain from sale of capital assets
Includes paying owner/operators time &
management
NFI = NFIfO Unpaid Labor & Management
+ Capital Gains
NFIfO vs NFI
A farm is a mix of different activities: labor, management,
investment, financing, etc.
NFIfO: trying to get at the crop growing and livestock part
of the operation, not investment or management
NFI: tries to get at all the farm business: pay yourself for
management, plus investment earnings included
Return on Assets (ROA)
ROA = Revenue Operating Costs Unpaid
Labor & Mngmt + Capital Gains
ROA = NFI + Interest
Income generated by all Farm Assets, including
investment income
Dont Subtract Interest
Interest = cost of using someone elses money
so your far can have more assets than just what
you can own with your equity
ROA wants to calculate income generated by all
assets, yours and other peoples
Other terms: Return to Capital
Return on Assets (ROA)
Estimate cost of Unpaid Labor and Management
What it would cost to hire someone to do all the
currently unpaid labor and management?
What would you/family make at your next best
alternatives (opportunity costs)?
Removing Unpaid Labor and Management
arbitrary, but important
Whatever chosen changes estimated ROA
If ignore unpaid labor and management (many
do), will get higher ROA
Know these issues before you compare with
other businesses and with market returns
Rate of Return on Assets (ROROA)
ROA compared to size of business
How much income is the farm generating
relative to the amount of assets used?
ROROA = (ROA/Average Assets) x 100
Average Assets = average of assets over the time
period of the Income Statement
Go to Balance sheet and use average of total
assets (current and non-current) at start and
end of period
Rates of return are why Balance Sheet and
Income Statement go together
Rate of Return on Assets (ROROA)
ROROA = (ROA/Average Assets) x 100
Average Assets = size of business during the
accounting period
Which basis for asset valuation: cost or market?
Market basis to compare farms and to compare
to liquidating and getting market rates of return
on financial investments
Use cost basis to look at your trend over years
Compare ROROA only if done in same way,
especially asset valuation
Do not include non-farm assets and income
Return on Equity (ROE)
ROE = Revenue Operating Costs Interest
Unpaid Labor and Management + Capital Gains
ROE = ROA Interest
ROE = NFI
Of all the income generated by the Farm Assets,
the part that goes to you as holder of equity in the
business
Return on your equity invested in the farm
Rate of Return on Equity (ROROE)
ROROE = (ROE/Average Equity) x 100
Average Equity = average of equity at the
beginning and end of the period
Obtain from Balance Sheet
Like ROROA, except use ROE, not ROA
ROE removes Interest from ROA
Interest is farm income to pay for debt equity
Interest is the ROE for the bank, and Interest
Rate is the banks ROROE
 ROROA, ROROE and Interest Rate

Interest the only difference between ROE and ROA

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
If ROROA > Interest Rate, then extra generated from
use of external funds goes to increase ROROE
Operating Profit Margin Ratio (Profit Margin)

Operating profit as percent of Revenue

Operating profit = Return on Assets
Operating Profit Margin Ratio
= ROA/Total Revenue
Of all revenue generated by the business, how
much does the business keep?
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
Measures from Income Statement
Net Farm Income
Net Farm Income from Operations
Return on Assets and Rate of Return on Assets
Return on Equity and Rate of Return on Equity
Profit Margin
Look at example rates and margins
Look at example income statement
Rates of Return in Dairy
UW Center for Dairy Profitability
[Link]
[Link]
Two methods
Assets at Cost Basis with Tax Depreciation
Assets at Market Basis with Economic Depreciation
Does NOT include cost of unpaid labor and
management or opportunity cost of owner
equity
Average Profitability in WI Dairy
Cost Basis and Tax Depreciation
2002 2001 2000
ROROA 4.00% 10.01% 7.91%
ROROE -1.69% 16.15% 9.07%
Profit Margin 4.99% 12.38% 10.25%

Market Value and Economic Depreciation

2002 2001 2000
ROROA 2.17% 5.65% 4.24%
ROROE 0.05% 4.82% 2.34%
Profit Margin 5.79% 13.31% 10.52%
ROROA in WI Dairy: AgFA Farms

RORO 2002 Range of ROROA

Year A Year ROROA Range % Farms
199 < 0% 35.5%
5 5.57% 2005 6.77%
0% - 2.5% 20.1%
199
2.5% - 5% 16.3%
6 5.36% 2006 3.25%
5% - 7.5% 14.0%
199
7 5.42% 2007 8.39% 7.5% -
10% 7.1%
199
8 9.20% 2008 6.49% > 10% 7.1%
199
* Assets at Market2009
9 7.56% Value and Economic
-1.65%
2009: A Bad Year for Dairy
473 AgFA farms in 2009
NFI ROROA ROROE
Top 40%: $77,098 3.32% 2.63%
The Rest: -$23,794 -7.84% -2.83%
Range of ROROA in 2009

Even in Bad years,

some farms make
money
Source: [Link]
IA 1990-1998 by Type and 2000-2006
IA 1990-1998 ROROA ROROE Profit Margin
Grain 7.3% 6.0% 22.3%
Hog 7.4% 6.3% 20.9%
Fed Beef 6.0% 4.6% 23.1%
Cow-Calf 4.5% 2.6% 16.0%
Dairy 7.6% 7.5% 21.1%

Profit Current Debt to

IA 2000-2006 ROROA ROROE Margin Ratio Asset
Top 20% 12.8% 15.1% 22.9% 3.45 0.41
Upper 20-40% 11.4% 12.7% 20.1% 3.44 0.37
Middle 20% 7.9% 8.1% 17.0% 2.50 0.37
Lower 20-40% 9.2% 11.5% 16.7% 1.87 0.36
Lowest 20% 4.4% 2.9% 9.0% 1.62 0.44
Source: [Link]
IL and MN 2004

IL 2004 ROROA ROROE

Grain 6.2% 7.1%
Hog 13.4% 19.2%
Beef 2.9% 2.6%
Dairy 9.6% 11.2%

MN 2004 ROROA ROROE Profit Margin

Average 8.0% 10.9% 17.6%
Top 20% 13.4% 20.8% 26.0%
Btm 20% -2.7% -18.0% -8.0%
Farm Accounting Programs
(from Jenny Vanderlin, UW CDP)
AAIMS: Agricultural Accounting and Management
Information System
UW CDP developed and CDP, UWEX supports,
cheap ($150) for dairy only
AgManager by AgriSolutions
General farm accounting, Badgerland FCS
Redwing sells CenterPoint and Perception
More expensive, used by ag accounting firms
CenterPoint is newer, more for farmers
Farm Accounting Programs
(from Jenny Vanderlin, UW CDP)
Several Others: Farm Fund$, PeachTree,
QuickBooks, Quicken, MoneyWorks
CDP and UWEX do presentations and workshops
for farmers to learn more about these
Heart of the Farm, Annies Project
UWEX as requested
WI Farm Management Associations
Fox Valley Farm Management
[Link] Appleton, WI
Lakeshore Farm Management
[Link]
Valders, WI
Farm Credit Services [Link]
GreenStone (Appleton)
Badgerland (Baraboo)
United (Wausau)
AgStar Financial Services
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