Farm Finance Blog

Financial Statements:
Looking at the Big Financial Picture

By Jody Padgham

I’ve done several trainings for farmers on various aspects of farm financial management. Generally those attending know that they need to create financial statements, but don’t necessarily understand what the statements tell or can be used for.

In my role as Financial Director at MOSES, I regularly use financial statements to help assess and show others how stable the organization is, how our financial situation is changing over time, and how we are projecting things will look in the future. I find financial statements to be key in helping me to describe the overall financial health of the organization to others: those interested in investing in us (funders), those involved in making decisions about the organization’s goals (board members), and those who make management decisions (management team). Although a farm will have different people interested in the information (bankers, owners and farm managers), financial statements are equally useful and necessary to the farm business.

This is a good time to be thinking of financial statements, as farm statements are generally created annually for the calendar year. Right about now you should be making sure that you’ve collected the information you need to create the statements, or setting up systems to collect it in the coming year if you haven’t done so.

The Big Three

One of the most important financial statements I use is the Balance Sheet. This is a snapshot look at the financial status of the business or organization on a given date (for farms, usually Dec. 31, or the last day of your fiscal year). Balance sheets can be tricky to understand, as they use some terms that we don’t regularly use in other parts of our life—such as assets (anything of value that is owned, current, intermediate or long term), liabilities (debts or obligations, current, intermediate or long term), and equity (the value of the business beyond what is owed, the ownership).

Your banker or loan officer will be very interested in your balance sheet, and how it changes from year to year. Your balance sheet shows how much debt you have obligated, if a lot of people owe you money, and how much you have invested in the business.

Computer bookkeeping programs will create a standard balance sheet, but farm businesses track some balance sheet items uniquely. Those using computer programs will want to export the numbers and make adjustments to create a true farm balance sheet. Those using paper recordkeeping systems can use a premade template to fill in a balance sheet.

The Income Statement looks at the financial activity of your business over a period of time, generally one year. The income statement will report your income and compare it to your expenses. Because of adjustments that need to be made for things like prepayments, the using up of stored items or set-aside of items for use in upcoming years (change in inventory, like feed or fertilizer, etc.), and entries made for the depreciation of buildings and other assets, the income statement won’t be an expression of how much money you have left in your checking account at the end of the year.

What the income statement will tell you is what your true farm earnings were for the given period, how much value you added or took away from the operation, and, what your “net farm income” or “farm profit” was.

Again, your banker will be interested in the income statement to see if the farm is generating a net profit from year to year. You can use it to see if you are generating enough income from your farm product sales to cover the associated expenses. As with the balance sheet, your computer bookkeeping program will generate an income statement (also called a profit and loss), but it will have to be adjusted for your farm business.

The Cash Flow Statement will show you how cash is flowing into and out of your business. If done as a prediction on a yearly basis, it will estimate how much cash you will add to or take from the business on a monthly and annual basis. It will help you to see when you might want to try to delay purchases or speed up sales to try to even out cash flow. The cash flow will take into account cash inflows from things like sales, rent and government payments and outflows such as purchases, loan payments, wages and family living draws.

A cash flow projection can be used as a budget for an upcoming year, with management decisions made while creating it to smooth cash flow. Developed at the end of a year, a historical cash flow can show how much cash was added into or taken away from the operation in a given year. This will be the statement that helps you understand why your bank account is higher or lower at the end of a farm year.

Generally, your computer bookkeeping system won’t do a very good job of creating a cash flow statement. These are usually developed in a spreadsheet from numbers generated in the bookkeeping system.

Putting Them Together

The beauty of all three statements is their universality and the helpful information that can be generated by combining the statements in various analyses.

These three statements have been recommended and required by bankers and business people for generations. Although there can be variations in the numbers individual farmers choose to put into the statements, for instance whether the value of farm equipment is listed as its purchase price or at its current value, or if off-farm income or adjustments for owner labor are included in the income statement and cash flow, the statements can generally be compared from one farm to another and standardized comparisons (using ratios) can be made.

In the last several years, with the advent of computerized bookkeeping, we are seeing financial statements from numerous farms merged and averaged to create readily accessible “benchmarks,” or industry averages that you can compare your own operation to. Extension Services, technical colleges and others have done some work to make benchmarks for different types of farms available, though information on organic operations has been slower in coming. The University of Minnesota “FinBin Farm Financial Database” is one place where organic farm financial data has begun to be collected. (Go to http://www.finbin.umn.edu and click on “generate a benchmark report.” You can select “Organic” in the “special sorts items to include” and then select other options that fit your farm size and type.)

Highly diversified or unique operations will struggle to find benchmark data, and instead must rely on comparisons to previous self-generated financial statements to assess performance over time.

Those new to farming will be asked by their banker to provide 3 to 5 years of projected financial statements to justify a loan application. In established industries these projections can rely on similar benchmarks, those planning unique operations will have to do research to project and justify their assumptions.

More Value over Time

Anyone involved with farming, whether as a new or experienced farmer, will want to become familiar with these three standard financial statements. Although they look complicated at first, as you work with them from year to year you will gain understanding of what must be collected to create them, and why and how the financial situation on your farm changes. The use of ratios, as well as a good tax accountant or advisor can help point out trends or issues to watch over time.

Having been responsible for the financial management of MOSES for over 10 years, I rely on my financial statements as a steady and simple way to assess the health of the organization. I actually look forward to creating my reports (which I do on a quarterly basis) so I can get that numerical reinforcement of how I feel the organization is doing. I hope that you can prioritize time each year to sit down with your financial statements, whether you create them yourself or have someone do them for you, and learn to understand what they are telling you about your business.

Information on how to create each of these financial statements, as well as how to use them to assess the health of your farm business, is in Fearless Farm Finances, the farm finance “bible” published by MOSES in 2012.

Jody Padgham is the Financial Director for MOSES, and Associate Editor of the Organic Broadcaster.

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