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Extension Extra SDSU Extension
5-1-2004
Record Keeping in Farm Management
Agustin Arzeno
South Dakota State University
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Arzeno, Agustin, "Record Keeping in Farm Management" (2004). Extension Extra . Paper 179.
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ExEx 5054
May 2004
Economics
COLLEGE OF AGRICULTURE & BIOLOGICAL SCIENCES / SOUTH DAKOTA STATE UNIVERSITY / USDA
Record Keeping in Farm Management
Agustin Arzeno
Area Management Specialist
Introduction 2) Obtaining credit: If you decide to borrow money for
The purpose of this document is to discuss the importance your farm business operation, the loan officer or bank will
of farm record keeping and provide producers with ask to see your financial records including a balance
methods to start record keeping practices or improve sheet, an income statement and a cash flow statement. The
their current procedures. creditor will require these statements in order to determine
your repayment capacity.
Today’s complex world economy and the rapid pace of
the farming industry makes it impossible for producers to 3) Management tool: Accurate financial records, along
manage a farm enterprise the way their parents did 30 with production data, will help the farm business operator
years ago. Without a proper understanding of record analyze the information and make the necessary
keeping and its current and future implications, the farm adjustments to operate more efficiently, thus increasing
operator will not make it very far in today’s business profitability. Such analysis will help you plan for the
environment. future, and it will pinpoint the weaknesses of your farm
business and allow you to act accordingly.
Many farm operations are facing significant financial
distress due to drought conditions across the state of Characteristics of record keeping systems
South Dakota. This, coupled with a poor understanding of Keep the following guidelines in mind when implement-
financial performance, generates serious problems for ing or reviewing your financial record keeping system.
many producers, who may be facing farm business bank-
ruptcy. Producers can do little about the drought, except • Keep it simple! If the record keeping system is
taking precautionary measures and implementing water unnecessarily complicated, you are more likely to
management techniques, but they can do a lot with respect make mistakes.
to financial performance. • Maintain financial records that have the appropriate
level of detail depending upon the complexity of your
The first and most important step in taking control of your business. A more complex farm operation requires a
farm operation’s financial well-being is to keep good and more detailed system.
accurate financial records. Do you want to know where • Make sure that your records provide essential
your business is going? Do you want to avoid jeopardizing information on a timely basis.
your borrowing capacity? If you answered YES to these • A record keeping system should include the following:
questions, this publication is for YOU. - A business checking account to handle business
transactions.
The importance of farm record keeping - An income ledger by calendar month.
There are three main reasons farm operators should keep - An expense ledger by calendar month.
good financial records: - An inventory ledger for physical counting and
valuation.
1) Income tax reporting: A good set of records is required - A depreciation schedule for pro-rating original
for the preparation of complete and accurate tax docu- costs of assets.
ments. Poor records often lead to preparing income tax - A balance sheet to determine net worth.
returns that result in either underpayment or overpayment - An income statement to determine net profit or loss.
of taxes. This might get the tax reporter into trouble if - A cash flow statement to measure flow of funds.
there is an unexpected IRS audit of records.
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Record Keeping Methods 2) Keeping and using inventories: Progress in the farm
Basically, there are two primary methods for record business operation cannot be determined from year to year
keeping: without an annual inventory. Using the cash method for
record keeping –– that is, keeping a record of receipts,
1) Cash method: All items received during the year are expenses, and purchase cost of feeder livestock sold during
included in the gross income and expenses are deducted in the year, plus depreciation schedules –– will suffice to
the tax year they are paid. arrive at net income for tax purposes. However, this proce-
dure does not reflect any changes in inventory in the farm
2) Accrual method: Income is generally reported in the business operation. When these changes are recorded, net
year it is produced or earned, and expenses are deducted or income can be calculated using the accrual method.
capitalized in the year they were incurred, not necessarily
in the year received or paid. What should you inventory? Almost everything: Money
(receivables and payables), livestock, crops, supplies, and
The accrual method is recommended, because it provides property. The main problem in dealing with inventories is
inventory reconciliation and computation for “actual” net arriving at a value for different farm products and property.
income; thus it is helpful in making managerial decisions. There are six methods approved by the IRS:
Phases of Record Keeping a) Market cost: assets are valued at their purchase price.
Like a puzzle, there are several pieces that need to be put (Especially assets that are going to be used on a
together in order to see the complete record keeping short-term basis). This is used for tax purposes.
picture. The four basic phases or “puzzle pieces” for record b) Net market price: this is the net price after deducting
keeping are: transportation and marketing charges. Used mainly with
livestock and crops.
1) Recording receipts and expenses. c) Cost or market, the lowest: use the actual cost of
2) Keeping and using inventories. producing (or purchasing) the inventory item and
3) Recording crops and livestock information. compare it with the current market value of the item.
4) Analyzing the farm business. d) Farm production costs: this is determined by the cost of
producing a commodity on the farm, e.g., farm-raised
hay for livestock. In this case, the hay produced would
3) Recording crops
not include a profit or interest on investment.
1) Reco rd in g
receipts and and livestock
e) Cost less depreciation: this applies to assets that have a
exp en ses in formatio n useful life longer than a year, such as machinery,
buildings, and breeding livestock. These assets decrease
in value over time and the change in value becomes a
RECORD business expense called depreciation.
KEEPING
f) Cost plus appreciation: periodically, land values need to
Phases
be adjusted. This should be done every 4 to 5 years.
Examine this option carefully and cautiously.
2) Keeping and 4) Analyzing the farm
Using inventories b usiness 3) Recording crops and livestock information: The most
important elements of this phase are method and organiza-
tion. The farm business operation should have a complete,
but simple, filing system that includes, through field
Record keeping phases or “puzzle” records, all the relevant information pertaining to the
different farm enterprises. When this information is record-
1) Recording receipts and expenses: Record all receipts, ed annually, the producer will be able to use it to make
including payments from crop or livestock sales, ag crucial production decisions and set goals for the future.
program payments, crop insurance proceeds, custom hire
work, etc., as well as expenses, such as cost of feed, 4) Analyzing the farm business: Until the puzzle is
chemicals, breeding fees, seeds, fuel, interest, etc. finished, the complete picture is difficult to perceive.
Recording this information is basic for income tax Without this last piece of the puzzle, the main purpose of
reporting purposes. With each entry, include date, keeping good farm records will not be achieved. The
customer’s or vendor’s full name and address, description previous three phases will give the producer some
of the transaction, method of payment, check number, etc. indication of business performance but this last phase will
Use the income and expenses ledgers for this purpose. help you understand:
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• Where the income was produced. 2) Liquidity: measures the ability to meet financial obligations
• Strengths and/or weaknesses of the farm business. as they come due without disrupting the normal operations of
• Returns for labor and management. the farm business.
• Trends in net worth.
• The operation’s production efficiency. Once the results of the balance sheet are in place, the analysis of
the financial condition of the business is done through financial
This last phase or “piece” is what completes the puzzle, and it ratios.
will allow the producer to see the complete picture of the farm
business operation. Records that are properly kept, organized, There are three main ratios to analyze solvency:
and analyzed can provide answers that lead to better manage-
ment decisions. 1. Debt to Assets = Total liabilities
Total assets
Record Keeping: Financial Statements
Producers should maintain the following financial statements: a This ratio measures what part of total assets is owed to lenders.
balance sheet, a statement of owner equity, an income statement, This ratio should have values less than one and even smaller
and a cash flow statement. values are preferred.
Balance sheet: This is a statement of the financial condition of 2. Equity to Assets = Total equity
a business. It shows the status of the farm business assets, Total assets
liabilities and owners’ equity at a specific time. It is a snapshot,
not a motion picture, and must be analyzed with reference to This ratio measures what part of total assets is financed by the
comparative prior balance sheets. In summary, it shows what is owners’ equity. Here, higher values are preferred, but this ratio
OWNED (assets) and what is OWED (liabilities), and the cannot exceed 1.0.
difference between them, which is called NET WORTH. The
term “balance” comes from the requirement that the ledger be in 3. Debt to Equity= Total liabilities
balance through the basic accounting equation of: Total equity
Assets = liabilities + owner equity This ratio measures what part of the financing is provided by
lenders in relation to what is provided by the business owner.
All farm operations balance sheets follow a similar format. In Smaller values are preferred and this ratio will approach zero
the sample below, assets are shown on the left and liabilities and as liabilities approach zero.
owners’ equity on the right of the balance sheet.
Two computations are used to analyze liquidity:
Sample balance sheet
1. Current Ratio = Current assets
Current liabilities
Ratio values larger than 1.0 are preferred. A value close to 1.0
indicates that although there are enough assets to cover current
liabilities, there is no margin for error. Therefore, the higher the
ratio value, the better. However, a very high value for this ratio
might indicate too much cash on hand, which could be invested
elsewhere, thus providing some interest. A good balance is
preferable.
2. Working Capital = Current assets – Current liabilities
Although working capital is not a ratio, it measures the dollars
Measuring the financial position of a business at a point in time that would remain after selling and paying all current liabilities.
is done primarily through the use of two concepts: Negative working capital values, or values close to zero,
generally indicate some sort of financial distress. In any case, it
1) Solvency: measures the liabilities of the business relative to is important to relate the amount of working capital to the size
the amount of owners’ equity invested in the business. It also of the business.
provides an indication of the ability to pay off all financial
obligations if all assets were sold.
3
Statement of Owner Equity: The balance sheet shows the Profit Margin = Net farm income
amount of owner equity at a point in time, but not what caused Total revenue
the changes in this value over time. The statement of owner
equity shows the sources of changes and the amount that came Other profitability ratios include: rate of return on assets (ROA)
from each source. and rate of return on equity (ROE).
The table below shows an example of a statement of owner Example of net farm income under the accrual method
equity, where the beginning owners’ equity of $598,566 is
increased to $668,412 at the end of the year. Where did this
increase of $69,846 come from? It came from adjusting taxes
paid, increases in the current portion of deferred taxes, net
withdrawals from the farm, increase in the market value of farm
assets, and the subtraction of additional income taxes.
Sample owner equity statement
A statement of owners’ equity pulls together accounting infor-
mation from a number of sources to document and reconcile the
reasons behind any change in owners’ equity. Any failure to Cash Flow Statement: A sound balance sheet and/or a high net
completely explain the changes indicates a poor accounting farm income does not necessarily mean that the operation can
system.It’s just like balancing a checkbook. meet financial obligations. You must know the flow of income
and expenses during the accounting period to determine your
Income Statement: This is a summary of revenues and expenses ability to pay bills and creditors. A cash flow statement can be
for a given accounting period. The difference between the defined as the SOURCES (cash inflow, receipts) and USES
revenues and expenses is called net farm income. A positive (cash outflow, expenses) of funds. Sources would also include
difference indicates a profit and a negative value indicates a loans received, non-farm income, etc. Uses would include
loss. Under cash accounting, the above explanation would family living expense and loan repayments. Monthly comparison
suffice for tax reporting purposes. However, the cash method as of the sources and uses of funds will allow you to determine the
a way of measuring net farm income can be misleading and months where funds are needed (deficits) and the months where
result in poor decisions when used for management purposes. funds are in excess (surpluses).
If accrual accounting is used, the necessary adjustments to Choosing a record keeping system
reflect beginning and ending accounting period differences, such There are numerous kinds of farm record keeping systems
as variations in inventories, accounts payables and receivables, available on the market. For example, QUICKEN® computer
accrued expenses, etc, are included in the net farm income eval- software is widely used to keep financial records. Research the
uation. A practical way to account for such adjustments is to use different options before deciding on the right system for your
schedules for the different accounts. Producers who report net operation. Look for one that fits your specific farm operation. It
farm income on a cash basis should also compute their net should provide all the resources you need, not only financially
income by the accrual method in order to determine the true but also managerially.
income of their farm business operation for each year.
In addition to any record keeping system chosen by the
Once the net farm income is determined, the next step consists producer, the South Dakota Cooperative Extension Service
of assessing profitability through ratios. The most important of offers assistance with the use of FINPACK®, a financial and
these is the profit margin (PM) ratio. enterprise management software package, developed by the
University of Minnesota. FINPACK® allows the user to track
A simple way to calculate it is as follows: financial progress and to analyze the overall farm profitability
by farm enterprise.
4
Conclusion References
Good record keeping is important, not only for tax purposes but Farm Business Records, by Richard Carkner, Extension Economist, Washington
also for efficient farm management. Using financial records and State University.
Farm Record Keeping, by John Schlender, Extension Agricultural Economist,
methodology will help you understand how and where your Kansas State University.
business is going. Record keeping and sound data interpretation Farm Financial Management Articles, Iowa State University.
will help you define the weakest links of your farm Farm Management, 5th edition, by Ronald Kay, William Edwards, and Patricia
business operation and enable you to start corrective action Duffy.
US Small Business Administration.
plans. If you feel overwhelmed by the task at hand, or do not QUICKEN®, is a trademark and software owned by Intuit Inc.
know how and where to start the record keeping, contact your FINPACK®, is a trademark and software owned by the University of Minnesota.
local cooperative Extension office for assistance.
This publication can be accessed electronically from the SDSU College of Agriculture & Biological Sciences publications page at
http://agbiopubs.sdstate.edu/articles/ExEx5054.pdf
Issued in furtherance of Cooperative Extension work, Acts of May 8 and June 30, 1914, in cooperation with the USDA. Larry Tidemann, Director of Extension, Associate Dean, College of Agriculture
& Biological Sciences, South Dakota State University, Brookings. SDSU is an Affirmative Action/Equal Opportunity Employer (Male/Female) and offers all benefits, services, and educational and
employment opportunities without regard for ancestry, age, race, citizenship, color, creed, religion, gender, disability, national origin, sexual preference, or Vietnam Era veteran status.
ExEx5054. PDF May 2004.
