Your Net Income Statement

Gerry Schwab, Barbara Dartt, Sherrill Nott, Roger Betz and

other FIRM AoE Team Members

Day 2 -- morning

Farm Financial Management

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

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

Net Income StatementFor: ___________________________

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 AdjustmentsBreeding 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)

Building an Income Statement

• NEED:– ALL Cash Income– ALL Cash Expenses– Plus Accurate Beginning

and Ending Net Worth Statements to calculate changes in inventory

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

Financial Statement Linkages

Dec. 31, 19X1 Dec. 31, 19X2 Dec. 31, 19X3

Historic Projected

Balance Sheet12/31/X1

Balance Sheet as of 12/31/X2

Statement ofOwner Equity as

of 12/31/X2

Pro FormaBalance Sheetas of 12/31/X3

(Flow Statement)

Cash Flow Budgetfor 12 months

ending 12/31/X3

Pro Forma IncomeStatement for 12months ending

12/31/X3

Income Statementfor 12 months ending 19X2

Statement of CashFlows for

12 months ending19X2

Source: Agricultural Financial Reporting & Analysis

Net Farm Income

• Unpaid family and operator labor

• Unpaid management• Unpaid equity capital

PURPOSE:

Indicator of Farm Business Profit earned during the accounting period

Net farm incomeis the RETURN TO:

+ $ Gross farm income+ Ending inventory of- Beginning inventory of- Ending inventory of

accounts payable+ Beginning inventory of

accounts payable- Cash operating expenses

CALCULATION:

Crops, feed market livestock, accounts receivable, and capital adjustments (depreciation)

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.

CALCULATION:

$ Net farm income

$ Gross farm income

Rate of Return on Farm Assets(or investment)(ROA or ROI)

PURPOSE:

To determine the before-tax rate earned by the $ of capitalinvested in the business.

CALCULATION: $ Return on Farm Assets

$ Average Total Farm Assets

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

Rate of Return on Equity Capital

(ROE)

CALCULATION:

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.

$ Net farm income

- $ Opportunity Cost for: Unpaid labor and Management

$ Average

Net Worth

X 100 (to get on a percentage basis)

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

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:

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

Operating Profit Margin

PURPOSE:

To determine the operation efficiency of the business. It indicates the percent profit earned per dollar of value produced.

[($ Net Farm Income

+ $ Interest Expense

- $ Opportunity Cost for unpaid labor and management)

$ Value of farm production]

x 100

CALCULATION:

=

Operating Profit Margin

X

Asset Turnover Rate

% Return on Investment

If % ROA Is Not Satisfactory

Must Increase1. Operating Profit Margin

and/or

2. Asset Turnover Rate

To Increase Operating Profit

MarginNeeds:• 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 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

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.

Capital Replacementand Term Debt

Repayment MarginPURPOSE:

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.

+ 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

CALCULATION:

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.

($ Total Farm Operating Expense

- $ Farm Interest Expense)

$ Gross Farm Income

CALCULATION:

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

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.

($ Interest Expense

± Change in Accrued Interest Expense)

$ Gross farm income

CALCULATION:

Framework for Financial Analysis

Framework for Financial Analysis