Unit 3 Analysis of Farm Records and Accounts PDF

Unit 3 Analysis of Farm Records and Accounts  Farm Records Farm records are the systematic documentation of all activities taking place in a farm enterprise over a given period of time.  Farm records are important to the financial health of the farm.  Farm re...

Unit 3 Analysis of Farm Records and Accounts  Farm Records Farm records are the systematic documentation of all activities taking place in a farm enterprise over a given period of time.  Farm records are important to the financial health of the farm.  Farm records are like grade report papers students receive in higher institutions. With a farm record report  you can tell how well you are managing your business operation $  you can see the strengths and weaknesses of your farm operation  CONT’D… Farm record book is an account of the various activities carried out on the farm on a regular basis  Such activities include: 1. Farm purchases, 2. Utilization of farm inputs, 3. Number of livestock kept and 4. Equipment procured, 5. Crop cultivated, 6. Seed planted, 7. Cultural activities carried out, quantity harvested, etc.  The main Characteristics of a good farm record book 1. Simplicity, 2. Specificity, 3. Ease of accessing information and comprehensible to another user. 4. Simple and easy to understand 5. It should be suitable forms for recording the type of information the farmer wants to record 6. It should have provision for an itemization and classification of all entries; 7. It should have adequate space for itemization all entries, and the lines and spaces sufficiently wide for writing without crowding; and 8. It should have adequate instructions for recording and analysis of recorded data.  Types of farm records There are seven types of farm records 1. Farm tools and equipment inventory records 2. Income/Receipts Records 3. Home Consumption Record 4. The Crop and Livestock Expenses Record 5. Farm Labour Record 6. Durable Assets Depreciation Record 7. Net Farm Profit Record 1. Inventory Records  Inventory is refers to the listing of assets owned by the farming business The farm tools and equipment inventory contains information of the asset such as  Name, year of purchase, cost price, expected years of life,  The annual depreciation and beginning and end of year values. e.g. include crop and livestock inventory records.  2. Income or Receipts Records:  Contains  product sold, units produced and total value. 3. Home Consumption Record Contains  Home Consumption Record Contains  the product,  price per unit,  total weight and  the value of home consumed products.  Cont…  In subsistence small scale farming the proportion of home consumed products out of the total production could be substantial.  is similar to the direct expense record  Shows date of purchases, the seller, quantity purchased, unit price and total cost  5. Farm Labour Record Includes both family and hired labour components On enterprise basis the  number of workers,  the hour spent by each person and  the wage are recorded.  Hired labour costs are often transferred to the general expense record.  6. Durable Assets Depreciation Record It records include:  type of asset, purchase date  condition at purchase,  purchase value,  expected useful life (service period), and the rate of depreciation of the asset. The data will help in determining the salvage value which is the value of the assets at the end of its useful life i.e., scrap value.  7. Net Farm Profit Record  It records  values and sources of receipts (crop, livestock),  value of home consumed products and  the gross farm receipts for a given year.  PART II Farm Accounting  Farm Accounting Commercial farming involves many transactions and book keeping Books of account present summary of records on business transactions. Accounting systems should be designed to  provide information efficiently and quickly at the least cost  offering protection to the business by exposing theft or fraud.  Types of Farm Accounts Some farm accounts that could be prepared and kept by a farm management include 1. Balance sheet and 2. Net income statements  A. Balance Sheet It is the net-worth statement. It shows the value of farm assets that would remain if the farm business is liquidated and all outside clams paid It is like taking a snap shot of the business at a particular point in time.  Cont… The net-worth statement sometimes gives information on the solvency of the business and is used as a basis for credit access. because  it shows the ability of the business to meet short-run financial demands.  if total assets exceed the total liabilities the business is solvent, that is, the greater the net-worth, the better the solvency position of the business.  Components of balance sheet statement 1. Asset (A) 2. Liability (L) 3. Net worth (C)  Asset (A) = Liability (L) + Net worth (C)  A=L+C  1. Asset Asset refers to anything of value owned by a business entity. A net-worth statement requires an  inventory of all properties or assets as well as  records of all liabilities of the business. types of Assets There are three classes of assets based on its immediate obligations or according to their liquidity.  Cont…. These are: A. Fixed Assets B. Working Assets C. Current Assets A. Fixed Assets  those assets which cannot be easily converted into cash.  Ex. land, buildings and other permanent improvement like fence.  B. Working Assets  those assets which are used up within the production process of the business.  They are liquidated at a faster rate than fixed assets.  Examples: Farm equipment like hoes and machete(axe), and donkeys, oxen…..  C. Current Assets: These are liquid assets Examples:  cash in hand  bills receivable within a short time  crops and feeds in hand  2. LIABILITY Liabilities are refers to those legitimate claims that can be made against a business. It is useful to have classification of the liabilities that correspond to that of the assets. There are three types of liability Liabilities are classified based on the time. due to payment.  Classifications of Liability These classifications of liability include 1. Long-term liabilities 2. Intermediate and 3. Current liabilities  1. Long-Term Liabilities:  Are those that will not fall due for payment in a lump sum within a short period of time,  fall due to a period like twenty years.  Examples:  real estate mortgages and long-term land leases.  These are not commonly used by subsistence farmers.  2. Intermediate Liabilities Are those obligations that are deferred (late or delayed) for the time being but which will be paid within a few years like five years or less. Examples are  promissory notes,  obligations based on crop or livestock in the process of production and ready to mature within a few years.  3. Current Liabilities: Current Liabilities refers to those obligations that are payable within a year. These payments when due demand the immediate attention of the farm manager.  3. Net-worth The net-worth statement is supposed to show  absolute equity or the amount by which assets in the business exceed its outstanding liabilities.  The net-worth figure indicates the solvency of the business. Ultimate solvency measures whether  total assets are equal to or greater than total liabilities the business is solvent.  total liabilities are not covered by total assets the business is insolvent or bankrupt (broke).  CONT’D..  The size of the net-worth figure, gives the farm manger an idea of the distance of the business from solvency.  The greater the net-worth means the farther away from insolvency.  Immediate solvency refers to the r/s b/n current liabilities and current assets which can be used to pay them off if the need arises.  CONT’D…  A farmer could be immediately insolvent, that is,  unable to pay its immediate debt.  if current, working and long-term assets do not exceed the sum of the current, intermediate and long-term liabilities.  b/c NW=A-L the result is negative, business is insolvent b/c AL. i.e. the debt pay immediate time Table 4: Example of Balance Sheet Statement as of Dec 31st, 2014 Current assets 56,400 Current liabilities 54,900 Non current assets 478,000 Noncurrent liabilities 173,000 Total assets 534,400 Total liabilities 227,900 Net-worth 306,500 Total assets Total liab. and Net-worth 534,400  CONT’D… Once balance sheet statement is prepared,  ratio analyses can be used to drive financial control functions which include.  measuring performance of business,  monitoring financial progress, and  determine trend of a farm.  Ratios can be compared across types and sizes of businesses more than money value.  B. Net Income Statement It is the statement which presents the difference between the gross receipt and total cost of production.NI=GR-TCP Sometimes it is referred to farm income or operating statement. net income statement construct based on types of record. Such as: 1. Farm inventory 2. Receipt records 3. Expense records and 4. Home consumption records.  Components of net income statement There are two components of the net income statement: 1. Gross receipt 2. Total cost of production 1. Gross receipt  it is total value of product.  It is the total output multiplied by price per unit of produce. i.e. Gross receipt = total output * price per unit of produce  Cont….  Gross receipt is composed from: 1. Sales of capital (e.g., machinery, if any) 2. Sales of crops, livestock and livestock products 3. Change in inventory of crops, livestock and livestock products 4. Product consumed in home 5. Accounts receivable 6. Non-farm receipts  Cont… 2. Total cost of production:  It is the sum of operating costs and fixed costs  This excludes family and operator’s labour and management A. Operating Costs  those costs are vary with the level of output and which need to be re-incurred at each period of the production process.  Cont… Operating cost includes: 1. Cost of hired labour 2. Machinery and equipment repairs & maintenance costs 3. Crop expenses, 4. Livestock expenses, and 5. Utilities (E.g, Light, water, telephone, etc.)  Cont… B. Fixed Costs those costs are do not vary with output in the short run.  FC costs must be met whether the harvest is good or not and whether we produce or not.  it include: 1. Depreciation on machinery and buildings, 2. Wages of permanent workers, 3. Interest on debt, 4. Property tax, 5. Insurance, 6. Repairs of buildings, 7. Improvement on land, etc.  Net farm income Net farm income is the difference between total revenue (gross receipt) and total cost. It measures the return to unpaid family labour, land, capital and management. Farm income = Gross Receipts –( total cost of production + change in inventory)  Table 5: Net income statement for year ending 31st December, 2010 Inputs Value Outputs Value Variable costs Sales and receipts Seeds 50 Livestock 44 Fertilizer 150 Chickens 150 Hired labour 200 Eggs 200 Feeds 120 Cotton 600 Groundnut 300 Sorghum 400 Sub-total 520 Sub-total 1,694 Fixed costs Home consumed product Taxes 10 Sorghum 600 Permanent staff 300 Vegetables 50 Repairing on buildings 50 Maize 420 Interest on debt 60 Sub-total 420 Sub-total 1070 Total cost of production 940 Total farm receipts 2,764 Opening inventory Closing inventory Sheep 144 Sheep 100 Chickens 150 Chickens 350 Ducks 50 Ducks 60 Grains 240 Grains 260 Fertilizer 100 Fertilizer 80 Goats 120 Goats 160 Sub-total 804 Sub-total 1,010 Change in inventory 1010-804 206 Net Farm Income =total farm receipts – total cost of production + change in inventory==2764-940+206=2030  Measures of Financial Success and Capital Position Components of the net-worth statement and the net income statements of the farm business can be used to indicate the strengths and weakness of the farm business in financial terms. An important function of management is to make use of these indicators in developing new plan and learn for better performance of the farm business.  CONT’D…. The net income defined as the gross farm income less gross farm cost. The net farm income could be improved by increasing the gross farm income or decreasing the farm costs or both. If the net farm income, is low the manager should examine the gross farm income which is directly related to the yield.  CONT’D…. The net farm income might be misleading because  it may not be a good reflection of the amount of capital, labour and management involved in the production process. It is, therefore, necessary to examine other measures of financial success such as return to labour, management, land and capital and.  Measures of Financial Success Depend on the three ratios (gross, operating and fixed) which are obtained from the net income statement. 1. The Gross Ratio is the Total Farm Expense (TFE) divided by the Gross Income (GI), that is: GR=TFE/GI Farm total operating cost is Birr 520 and the total fixed cost is Birr 420 and Birr 2,970 is gross income. Gross ratio (GR) = 940/2,970 = 0.32.  This ratio shows that the total farm cost was about 32% of the gross income.  Cont… The lower the ratio, the higher the return per dollar invested. If this happens management should consider ways of reducing costs and increasing gross income. The gross ratio measures the overall financial success of a farm. It is a long run planning tool for determining the performance of the entire farm business.  2. Operating Ratio  The operating cost is directly related to the farm’s variable input usage.  Operating Ratio is the total operating cost (TOC) divided by the gross income. OR=TOC/GI  OR =804/2,970 = 0.27  The operating ratio shows the proportion of the gross income that goes to pay for the operating costs.  3. The Fixed Ratio The fixed ratio (FR) is the total fixed cost (TFC) divided by the gross income (GI), that is: FR=TFC/GI Fixed ratio for the stated farm is calculated as FR = 420/2970 = 0.14. The ratio shows that the fixed expense is 14% of the gross income.  Measures of Capital Position While the measures of financial success are based solely on the income statement, the measures of capital position are based on data presented in the net-worth statement. The ratios which indicate how solvent the business is over different time periods are the 1. Current ratio, 2. Working capital ratio, 3. Net capital ratio, 4. Asset-to-debt ratio and 5. Debt-to-net worth ratio.  1. Current Ratio CR=CA/CL Based on the balance sheet statement given in Table 4 the current assets worth Birr 56,400, and the current liabilities amount to Birr 54,900 hence the CR is 56,400/54,900 = 1.03. A current ratio greater than 1 implies that the current assets is more than the amount the farm need to pay for the current liabilities. i.e CR>1=CA>CL The current ratio shows the ability of the business to meet financial obligations or its solvency.  2. Net Capital Ratio The net capital ratio (NCR) is defined as the total asset (TA) divided by the difference between the liabilities (TL) and the proprietor’s equity (PE). This ratio shows the overall solvency of the business, and Indicates changes that are possible in the future. It shows the degree of safety of the entire farm business and determines the possibility of borrowing more capital.  Example If the proprietor’s equity of the farm is Birr 100,000, the NCR is given by TA/ (TL-PE). Which means 534,400/(227,900-100,000) = 4.18. This ratio shows at a glance by how much the assets on the farm have to decline to be exceeded by the liabilities other than the proprietor’s equity. A high ratio is desirable for a risky firm business. Yet, a safe ratio depends on the type of farm and the degree of uncertainty and risks involved.  3. Asset-to-Debt Ratio is the total asset (TA) divided by the total liability (TL), that is: The asset to debt ratio is a close approximation of the net capital ratio if the proprietor’s equity is negligible. Example: Using data from balance sheet statement in Table 4 the ADR is calculated as: ADR = 534,400/227,900 = 2.34  4. Debt-to-Net Worth Ratio The debt to net worth ratio (DNR) is defined as the total liabilities (TL) divided by the net worth (NW), that is: This ratio indicates the ease with which the proprietor can meet financial debts internally when, and if the creditors demand.  Cont… A less than 1 ratio is preferred to enable the proprietor meet his financial obligations internally. The total liabilities (current, intermediate and long-term) given in Table 4 are summed up to Birr 227,900 and the net worth was Birr 306,500. Therefore, debt-to-worth ratio is equal to 227,900/306,500 = 0.74. This ratio of 0.74 indicates that the total liabilities were less than the value of the net worth. Hence the proprietor can meet its debts internally.