Enterprise Accounting:Key QuestionsChapter 18How are enterprises defined?How are income and expenses

allocated by enterprise?How are internal transactions

made?

Divide Farm into Enterprises(profit centers)

Commodity corn, alfalfa, beef cows, sheep

Stages farrowing, nursery, finishing

By production cycle (crop year) Cost Centers (machinery, labor)

Assign Income and Expenses1. Use account codes to assign direct

income and expenses Seed corn 631 Soybean seed 632 Alfalfa seed 634

2. Allocate “overhead” expenses among enterprises

By % of gross income By % of other expenses By acres

3. Include Internal Transactions

raised feed from crops to livestock

manure from livestock to crops

machinery services do not affect whole farm

income or expenses

4. Include inventory changes or other accrual adjustments if you summarize by accounting year

5. Not necessary by production cycle

Profit and Loss Statement for Farmsim

Income Total Crops Hogs Cattle

Sales $421,473 $49,117 $105,427 $266,929

Ins payments 0 0

Inventory chg -46,297 21,650 1,653 -69,600

Gross income 375,176 70,767 107,080 197,329

Feed purchased -77,013 0 -42,323 -34,690

Raised crops fed 0 30,642 -10,843 -19,800

Livestock purch -94,000 -1,600 -92,400

Value farm Prod 204,162 101,409 52,314 50,439

Verifying Inventories: Crops

Sources =+ Beginning

inventory+ Purchases+ Production

Uses Ending

inventory Sold Fed Spoilage Used for seed

Verifying Inventories: Livestock

Sources =+ Beginning

inventory+ Purchases+ Production+ Transferred in

Uses+ Ending inventory+ Sales+ Death loss+ Transferred out

Farm Business Analysis—Ch.18

What are the strengths and weaknesses of the farm business?

How can we measure how well the farm is doing?

Which farm would you prefer?

Farm A Net worth $200,000 Labor 12 months Net income

$30,000

Farm B Net worth $400,000 Labor 24 months Net income

$50,000

What Affects Net Farm Income and Cash Flow?

SizeEfficiency

Size or Scale of the Farm

Resources

Acres

Cows or sows

No.of layers

Total assets--$

Number of workers

Production

Pigs sold

Cattle fed out

Bushels sold

Lbs. of milk

Gross sales--$

Efficiency = production per unit of resources

Physical efficiencybushels per acrelbs. milk per cowpigs per sow per yearlambs per ewepounds of feed per lb. of gain

Economic Efficiency(value of product per unit or $

of resource)Crop value per acre--$Asset turnover ratio--%

= gross income / total assetsLivestock returns per $ of feed Gross income per person (FTE)

Economic efficiency also depends on:

Value of Product (marketing)

Sale priceQuality TimePlace

Cost of ResourcesSeed, chemicalsCash rentMachinery, fuelWagesFeed

Economic Efficiency

= Units of output x selling price

Units of resource x purch.price

Ex.: crop value per $ rent paid

160 bu. corn x $2.25/bu. price

1 acre x $145 per acre

= $2.48 per $1 spent on rent

Economic EfficiencyPhysical efficiencyMarketingCost of resources

Standards of Comparison

BudgetsHistorical records for the same

farmCurrent records from comparable

farms

Choosing the Right Enterprises

Fit the locationFit the operatorFit the resources

Net Farm Income also depends on how many of your resources you contribute yourself.

Operator labor instead of hired labor.Net worth capital instead of debt.Owned land instead of rented.Net Farm Income is a return to

operator labor, net worth and management.

Financial Structure

SolvencyLiquidityProfitability

SOLVENCY: Comparing assets to liabilities

Net worth - $

Debt-to-asset ratio (or other ratio)

Debt-to-asset ratios of 30 % to 40 % are typical, though many farms have no debt.

LEVERAGE: degree in debt

Total debt-to-asset ratio

<---10%-------20%--------40%------60%-->

low average high

High rates of profitability or low interest rates allow higher leverage to be sustained.

Liquidity(having cash when needed)Current ratio = current assets

current liabilities

Working capital =(current assets - current liabilities)

LIQUIDITYCurrent ratio should be 2.0 or better

Farms with continuous sales can have 1.5, but farms with infrequent sales may need 3.0

Working capital typically equals 25 % to 35 % of annual gross revenue

Dairy may be as low as 20% of gross revenue, cash grain as high as 50%

Profitability (income and expenses)

Net farm income value of unpaid labor ($/year) interest on owner equity (% interest rate x net worth)

= Return to managementThese are opportunity costs

Example

Net farm income

- value of unpaid labor (15 months @ $2,000)

- value of owner equity ($300,000 net worth @ 5%)

= Return to management

$65,000

$30,000

$15,000

$20,000

Profitability--% Return on Equity--%

= (NFI – unpaid labor) / farm net worth Return on debt capital (interest)

Interest paid for the year / total liabilities Return on Assets--%

(NFI – unpaid labor + interest expense paid)

Total farm assets

ROA is an average of ROE and the interest rate.

PROFITABILITY

Return on assets (ROA)

<---0%-------4%--------8%--------12%--->

low average good

Return on Assets--Iowa

8.4

5.0

6.0

3.73.2

7.57.0

5.8

-2.1

1.7

6.0

2.3

4.7 4.7

5.9

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04

%

Return on Assets to High Third and Low Third Farms in Iowa

-15

-10

-5

0

5

10

15

20

94 95 96 97 98 99 00 01 02 03 04

%

High Third

Low Third

Other ratiosGross revenue can be divided into:

operating expense (60 to 70 %)

depreciation (5 to 10 %)

interest (5 to 10 %)

net farm income (15 to 20 %)

High profit farms may keep 25 to 30 % of their gross revenue as net income

FINANCIAL PERFORMANCE MEASURES

1. Compare to similar farms.

2. Look at trends over several years.

3. Supplement ratios with production data and enterprise analysis.