What is flowing “into” your farm’s wallet? This question is the opposite of last month’s column and is equally important.
For a complete and accurate farm business analysis, we account for all of the dollars that came into the business, as well as all of the dollars that flowed out during the year.
At first glance, that is what an accrual adjusted income statement does. It details all of the dollars generated by the farm business and the expenses incurred to generate those income dollars. Or does it?
The income and expenses listed on the income statement detail the dollars that flow in from sales of farm products and the dollars that flowed out of the farm to produce those farm products. However, producing and selling milk, grain, livestock or other farm products is not the only reason dollars flow in and out.
So, how else do dollars flow in and out?
Sources of cash
- Farm only cash: At the beginning of the year, a farm has cash on hand in checking and savings accounts (maybe not so much in savings for the past few years). This can actually be a positive or negative balance.
- Gross receipts: Throughout the year new dollars flow into the farm business as it sells farm products, commonly referred to as gross farm receipts. (Think income statement!)
- Capital sales: As the farm sells unneeded or outdated machinery, equipment, vehicles, land, securities or other assets, they generate cash that flows into the business. Breeding stock sales to reduce herd size would also be a capital sale. These sale dollars are not part of gross receipts.
- Borrowed dollars: When the farm borrows money for operating expenses or purchasing productive assets (capital purchases), principal dollars flow into the business the year the dollars are borrowed.
- Capital contributions: Dollars may be contributed to the business from the farm owner’s personal resources or other sources that are not considered a loan. It does happen!
- Gifts and Inheritances: While not common, this does happen, and can be cash, or the cash value of other assets such as machinery and equipment, land, etc.
Uses of cash
- Farm only cash: At the end of the business year, how much cash is on hand in the checking and savings accounts?
- Total cash farm expenses: All farm production expenses, including interest paid during the year. (Think income statement!)
- Owner withdrawals: These will be included in cash farm expenses for LLCs and farms operating as corporations, but for sole proprietorships, this will be what was withdrawn for family living expenses/use.
- Capital purchases: Any purchases of machinery, equipment, vehicles, buildings, improvements, land, expansion breeding livestock, etc. for use in the farm business. Would also include the cash value of any noncash gifts such as machinery, etc. listed above.
- Principal payments: The principal portion of loan payments is accounted for here. Interest paid is included as a cash farm expense.
- Capital distributions: When farms have a good year, sometimes capital is withdrawn by owners or distributed among owners beyond the typical owner withdrawal/family living.
- Gifts given: I like this one, although I have never personally benefited from one of these! Occasionally there are dollars distributed as gifts to a church, other entity or to individuals. Gifts may be part of a transition plan for some farms.
- Income taxes: While we strategize to minimize tax liabilities, ultimately, we want the farm business to be so profitable that there are income tax liabilities. For sole proprietors, this would be a specific line item. Other entities might pass through cash to cover income tax liabilities as owner withdrawals or capital distributions.
Follow the money
One of the challenges farms experience in the first years of analysis is identifying all those other ways cash moves in and out of their farm business. Is it important? Absolutely, because we do not have a complete picture of the farm’s profitability until we can account for all dollars.
One of the simplest tools is to dedicate a folder each year to collect copies of the documents that describe the cash flow transactions above. Bought a new tractor with a trade and a new loan? A copy of the invoice and loan papers include all of the needed cash flow (and balance sheet) information.
Sold a skid loader? Include the model and sales price in your bookkeeping entries and the year-end capital sales report.
Principal borrowed and paid? Some lenders generate great year-end statements that list all loan activity for the year. Lenders who do not are usually very happy to generate these summaries when asked.
FINAN, the program used by the Ohio Farm Business Analysis Program, includes several internal accuracy checks covering cash flow, liabilities, net worth, and crop and feed inventories to ensure accuracy.
Without accuracy, we do not have a solid foundation to compare and benchmark the farm’s performance to itself or other farms.
Accuracy is not hard, it just takes a plan. Make a plan to answer the questions: What is flowing into and out of your wallet?
To get started with farm business analysis, contact me at email@example.com, or 330-533-5538.