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Understanding and using ag financial reports

Brian R. Bennett Published on 02 January 2015

When the topic of understanding and using agricultural financial reports surfaces in any discussion among production agriculture business managers or owners, you can be assured the discussion will be rather lengthy and that what financial reports they prefer depends on the current objective of the manager or owner.

Perhaps it may be easier to understand the use of financial reporting if we start with the view that financial reporting has three primary purposes:

  • Compliance – income and payroll tax
  • Credit – operating lines and capital purchases
  • Managing profit – information to improve the bottom line

This article is based on the assumption that you currently understand and use financial reports for compliance and credit purposes, and it will focus mainly on how financial reporting can assist you in improving your bottom line.

Your “bottom line” can include many financial factors, such as profitability, liquidity, solvency and financial efficiency. Each of these financial concepts may have more than one method of being calculated and reported.

Regardless of the financial concept you desire to measure and monitor, the third financial reporting purpose listed earlier, “managing profit,” is key to the other purposes.

Without profits, there is no tax to pay (even though you still have to report), and long term, no available credit (even though you may still apply for credit). Often, the challenge is to know what measurement of profitability is best to use and how profitability can be “captured” and reported by the financial reporting system being used.

For most agricultural operations, the use of cash-basis accounting and the filing of the Schedule F, Profit or Loss From Farming, may be the main source of reporting financial profitability.

However, while Schedule F is obviously useful for meeting compliance requirements for tax purposes, the profit reported on Schedule F does not provide management or owners a measurement of the true profitability of the business as a whole (entity level) or the true profitability of the business’s key products such as grains, forages and livestock (managerial level).

Product profitability is critical for management to make informed decisions on how and where to invest their time and resources to maximize bottom-line results.

Cash-basis accounting records a transaction only when cash has been paid or received. Thus, selling the 2014 crop in 2015 does not clearly match revenue and expense to provide true profitability for that crop.

Accrual-basis accounting records transactions when a legal transaction has taken place, i.e., inputs have been received (even if not paid for) or crops have been delivered.

In order to measure true profitability of the business as a whole (entity level) or the true profitability of the business’s key products (managerial level), accrual-adjusted measurements are needed, including the following types of information:

  • Inventory changes (grain, forages, livestock)
  • Account payables
  • Account receivables
  • Prepaid expenses
  • Growing crop investments

In addition to the accrual-adjusted measurements listed above, for true profitability to be known the following types of information are also important to be taken into consideration and reflected in the financial reporting:

  • The use of book or management depreciation versus the tax depreciation measures that may be used to impact taxable income. Tax depreciation is generally accelerated and does not reflect the true useful life of the assets.

  • For sole proprietorships, a method to reflect the value or true cost of the owner-operator’s management and labor.

As mentioned above, the accrual- adjusted reporting can be at two levels:

1. Entity level: accrual-adjusted profit and loss statement

2. Managerial level: accrual-adjusted reports by product center (i.e., grains, forages, livestock)

Accrual-adjusted profit and loss statements can be useful to the managers or owners for analysis and decision purposes, since this type of reporting more accurately matches revenue with the expenses incurred to produce the revenue and thus reflects true profitability resulting from management decisions or changes in the direction of the business.

Many lenders are also now requesting or requiring accrual-adjusted financial reporting, as many lenders also recognize the limitation of using strictly cash-basis reporting for analysis purposes.

As a further enhancement of this type of analysis, consider the use of trended financial reports for a three-year to five-year period.

Managerial-level reporting moves beyond the entity-level reporting and can be based on production cycles appropriate for the product without regard to the calendar year.

Entity-level reporting is based on a calendar-year or fiscal-year cycle. Livestock production cycles are generally reported on a calendar-year time period. Grain and forage production cycles are for time periods from the first crop input expense incurred until the last bushel or ton is sold and cash received, with the time period involving possibly 18 to 24 months or longer.

2015 Crop production cycle

While the timing of the planting and harvest will vary depending on what type of grain or forage is involved, Figure 1 is an example of a crop production cycle.

The use of managerial accounting can deal with issues such as:

  • Monitoring, measuring and controlling commodity and location costs
  • Monitoring costs of various production support activities
  • The analysis of incremental or marginal costs
  • The analysis of breakeven points
  • Monitoring the performance of staff

Managerial-level financial reporting is more comprehensive in its focus on the informational needs of internal users such as the manager or owner.

Previously, lenders have not typically been concerned with the managerial-level reporting, although in recent years I have encountered situations where the lender was interested in managerial-level reporting for performance of specific profit centers (i.e., grain, forages, livestock) relative to corresponding lines of credit designated for those various segments of the operation.

If you are using a financial reporting system in your business that is capable of recording and reporting accrual-adjusted financials, but you have not yet taken the necessary steps to learn, implement and use accrual-adjusted financial reporting to your advantage, commit to take those steps.

Understanding and using your financial reports to make sound management decisions can drive improvement of your bottom line results.

Should you desire to use accrual-adjusted financial reporting, in addition to your cash-basis reports, and your financial reporting system is not able to deliver accrual-adjusted financials, contact your system’s provider to see if that functionality is available.

If not, you may want to consider changing your financial reporting system to one that can.

While some production agricultural business managers and owners may be satisfied with reporting their profitability on cash basis only, maintaining the status quo is rarely the best management practice. Take the responsibility to find and utilize tools that make you a more effective business manager.  FG

References omitted due to space but are available upon request. Click here to email an editor.

Brian R. Bennett
  • Brian R. Bennett
  • Consultant & Data Analyst
  • AgriSolutions Inc.