Using Financial Statements to Strengthen Your Farming Enterprise
Frank Wiebe, Partner
BDO Dunwoody LLP
Oftentimes, farmers only look at their financial statements once a year: At tax time. But the fact is, using financial statements throughout the year can improve a farm’s bottom line by showcasing opportunities for improvement and providing a measuring stick by which farmers can achieve specific strategic goals and objectives; they can be a valuable tool in managing a farm’s viability and performance. Before you can use your financial statements in managing your farming business, you’ll need to understand some primary accounting principles and the basic components of financial statements, which include balance sheets, income statements and statements of cash flows.
Essentially, there are two methods of accounting: Cash basis accounting and accrual basis accounting. During the former, revenues and expenses are recorded when cash is actually paid or received. During the latter, revenues and expenses are recorded in the period they are earned. This method is more complex than the cash basis method, but it is also more accurate. It provides a continuous record of what you owe and what is owed to you, paints a clear picture of the assets currently in the owner’s possession and accurately depicts the farm’s financial position.
Financial statements are comprised of three main elements:
- Balance sheets
- Income statements
- Statement of Cash Flows
A balance sheet contains a summary of what the business owns, what the business owes and the net worth (known as Owner’s Equity, Partners’ Equity or Shareholders Equity) of the business at a specific point in time. All farm holdings are divided into assets (both current and long-term) and liabilities (also current and long-term). Having this information up-to-date and handy provides farmers with key information needed to make sure business goals are being met and that the business is viable and successful.
Income statements document the operating activity of the farm. An income statement shows the farm’s revenues, the value of all goods and services supplied by the farm; expenses, the amount of goods or services incurred; and the net income, the amount remaining once expenses have been subtracted from revenues; all within a specified timeframe. Regularly managing the farm’s income statement will enable the owner to capture and monitor changes to the Owner’s Equity and see how profitable the farm truly is.
Finally, a farm’s statement of cash flow illustrates the sources of incoming cash flows and outgoing cash flows during a specific period of time. It’s broken down according to operating activities, investment activities and financing activities to clearly show where the farm is earning revenue and where it’s paying expenses and debts.
| |
Incoming Cash |
Outgoing Cash |
| Operating Activities |
• Income from sales
• Collecting receivables |
• Paying expenses
• Purchasing inventory |
| Investment Activities |
• Sale of assets including land, major equipment, etc… |
• Purchase of assets |
| Financing Activities |
• Cash incurred loans, investments, etc… |
• Paying down debts or distributions to owners |
Linking all three financial statements together will provide a farm owner with a clear representation of where the farm is at fiscally. These statements can be used as an important tool to measure and attain long-term viability and success. Important liquidity ratios, outlining a company's ability to meet current obligations with cash or other assets that can be quickly converted to cash, and liability ratios, which highlight the farm’s long-term ability to meet all financial obligations, can be calculated to reveal the farm’s profitability ratio; the measure of performance showing how much the firm is earning compared to its sales, assets or equity.
So, why should farmers bother with all this? For starters, it’s required; you’re going to have to do it anyway, why not maintain these documents regularly throughout the year? By doing so, the farm owner will be able to see exactly what kind of fiscal shape the enterprise is in and will be able to make changes to ensure the farms profitability. The information provided in these statements is the crux of the farm owner’s financial toolkit, allowing for long-term analysis of the state of the farm as well as providing a base by which the farm owner can compare his or her operation to similar operations. Essentially, regularly maintaining financial statements will provide the owner with pertinent financial information needed to determine if strategic goals are being met and ways to improve farming operations.
