by Whitney Wiegel
Parsons, Kansas —
The United States Department of Agriculture Economic Research Service has recently forecast 2011 total net farm income for US farms at $100.9 billion. This number represents an increase of 28 percent from the 2010 net farm income level. These nation-wide numbers are impressive, but they do not tell a farmer much about his or her farm’s individual financial success.
As 2011 comes to an end and farmers begin to organize their financial records to prepare their 2011 tax returns, it is a good time for them to assess their individual farm’s financial performance. While many farmers rely on their Schedule F from their tax return to assess their profitability, tax returns are generally a poor way to assess financial performance. Since most farmers are on a cash basis for their taxes, their Schedule F statements do not show amounts for year to year changes in inventory, accounts payable, or accounts receivable. Changes in any of these three categories could significantly impact income for the year. Furthermore, the manner in which depreciation is calculated and used for tax purposes may differ greatly from true market value depreciation. It is for these reasons and others that a tax return should not be used to gauge farm income.
In order to accurately assess farm income for a given year, an accrual-based or accrual adjusted income statement should be generated. The purpose of an accrual income statement is to match income and expenses to the production year for which they were earned or expended. Since cash income and expenses for a production cycle are not always realized in the matching operating or record-keeping year, cash-based income statements do not often provide an accurate assessment of farm income for a given time period. An accrual income statement, like a cash income statement or Schedule F, shows net cash income. However, unlike a cash income statement or Schedule F, an accrual income statement incorporates changes in beginning and end of year inventories, accounts payable, and accounts receivable. It is the incorporation of these values that make accrual income statements superior to cash income statements at gauging financial performance.
Given that accrual income statements are superior to cash income statements and that accrual income statements require information about beginning and end of year inventories and account balances, the next issue becomes finding the information necessary to generate the accrual income statement. If a farmer uses a cash-based record keeping system, the best way to record and find this information is to generate or update a farm balance sheet at the end of each year. A balance sheet is a financial statement that summarizes all farm assets and liabilities at a given point in time. Metaphorically, the balance sheet is a snapshot of the farm’s financial position. The balance sheet includes an inventory of the farm’s assets and their values as well as an inventory of all the farm’s liabilities. By matching the date of the farm balance sheet to the ending date of his fiscal or tax year, a farmer can enhance his ability to generate an accurate accrual-based income statement.
To generate an accrual income statement for a given year, a farmer who uses a cash accounting system would need to calculate his net cash farm income for the year. Then, using the information he recorded on his beginning and end of year balance sheets, he can adjust his net cash farm income to reflect the changes observed on his balance sheets. The result of this process is an accrual-adjusted income statement that gauges the financial performance of the farm for a given year.
Farmers who would like more information about how to generate accurate financial statements, including income statements and balance sheets, should contact their local University Extension office. More information including a short online course on financial statements can be accessed through the University of Minnesota’s Center for Farm Financial Management website at http://ifsam.cffm.umn.edu/.
For more information, contact specialist’s name, number, e-mail or visit your local Extension Center or extension.missouri.edu.