Richard D. Duvick
DepartmentOf Agriculture, Environmental and Developmental Economics
The Ohio State
University, Columbus
A concern of many
financial consultants and lenders is that many farmers lack adequate records to
monitor and analyze the financial health of their farm business. Lack of
financial data makes it difficult to determine proper debt loads, or to develop
plans for businesses with major financial problems.
One result of the
financial crisis of the 1980's was the formation of a committee composed of
farmers, lenders, educators and others called the Farm Financial Standards Task
Force (Forbes, 1992). The efforts of this committee led to a set of guidelines
for a complete farm financial statements and how these statements could be
analyzed in a consistent manner. Included in the recommended set of financial
statements were: Balance Sheets, Income Statement, Cash Flow Statement,
Statement of Cash Flows and Statement of Owner Equity. A set of 16 measures was
then used with these financial statements to provide analysis.
Another issue is what
must be done to collect accurate and meaningful data that can be used by others
to analyze the financial situation of farm businesses and draw similar
conclusions. There was general agreement by the committee members that a
variety of methods could be used in collecting the necessary farm record
information: hand kept records, simple or complex computer systems. But there
was also an awareness moving to some sort of computerized record keeping system
would probably improve the accuracy and usability of the data.
Pencil and paper is
still the way most farmers keep records. Entering farm accounting records by
hand in the Ohio Commercial Farm Account, or a similar book may be all many
farmers need. As farm size and/or debt increases, many farmers and lenders look
for computer programs that allow fast data entry, have internal checks for accuracy
and allow summarizing the data in a variety of ways. Most begin their search by
asking "Is there a simple computer program that will keep my records like
the farm account books?"
Today there are
numerous commercial software programs that can do an excellent job of recording
basic income and expense data for farmers, plus quickly summarizing and
preparing a variety of financial reports. While not ruling out hand kept
records, there are some basic questions to consider in selecting a computer
record keeping system. The focus will be on software (computer programs that
performs various tasks) rather than the hardware (computer and printer). While
older computers may be inadequate for even the simplest accounting software
available today, $1,000 can buy you a computer and printer that will handle all
such programs. The decision to buy a bigger, faster computer will be more
dependent on other things you may want to use the computer for such as
connecting to the Internet or playing games that require a lot of graphics.
The main reason most
farmers keep records is for tax reporting. Tax records get more complex when
the business has employees. Other reasons given for keeping farm records are to
evaluate enterprises, develop accrual based financial reports and do financial
analysis. While tax record data is basic, the additional data needed for other
uses requires minimum time and effort.
In a farm business
some basic reports are needed. The key ones are: Transaction Journal: All cash
flowing into and out of the business. Depreciation schedule: For all
depreciable assets.
Employee reports: Paychecks, withholdings, payments of employment tax, W-2,
I-9, new hire reports, workers compensation and other reports.
Information returns:
1099 reports.
Balance Sheet and
Income Statement.
To report how the farm
business is doing requires at least two financial statements: the Balance Sheet
and the Income Statement. In addition, larger businesses may be required to
prepare a Statement of Cash Flows and a Statement of Owner Equity. All
statements should relate to the same time period, the business year.
The balance sheet
shows what you own, what you owe. The difference is owner equity at the end of
the business year. The balance sheet is helpful in acquiring debt, measuring
financial progress, considering risk and valuing ownership. The balance sheet
must be based upon an inventory taken at the end of the business year. The
income statement shows what the business earned during the business year. This
should be an accrual statement, accounting for all changes in inventory. Schedule
F from your tax return is not an income statement! It
only shows milk, crops and feeder livestock that you sold in that year. It does
not show changes in inventory nor sales of breeding livestock. A true income
statement will reflect what the farm actually produced during the year. To
develop one you must have detailed balance sheets from the beginning and end of
each year.
To benefit from these
financial statements a detailed analysis is necessary.
Analysis measures
include:
Liquidity: The ability of the
business to meet financial obligations as they come due.
Solvency: The amount of borrowed capital relative to equity.
Profitability: The amount of profit generated.
Repayment Capacity: The ability to repay term debt from farm and non-
farm income.
Financial Efficiency: The intensity of asset use.
The Farm Financial
Standards Task Force recommended 16 different measures to analyze the financial
well-being of a farm business under these five general headings (Forbes, 1992).
These measures are explained in several publications (Oltmans, 1992; Polson,
1996). A key question is, "How accurate are the financial statements used
to develop the measures?" Unless the financial statements are developed
using accepted procedures, the financial ratios may have little validity.
An accounting system
is simply a fancy term for farm records. But if users think of an accounting
system, they are more apt to think about the total data needed to create the
necessary reports and analyze them to determine what is happening in the
business. While this could be quite complex, users should think about four
types of data needed for the farm business accounting system:
The first three of
these are needed for tax returns. The only additional information needed to
create the financial statements are inventory data.
Farm record keepers
can pick their software from four groups:
Simple cash systems: Quicken
General cash/accrual
accounting systems: QuickBooks, DacEasy, Peachtree
Farm cash/accrual
accounting systems -PCMars, Transactions Plus (TA+) by FBS Systems, Red Wing
Add-ons for analysis:
spreadsheets, FINPACK, AFRA by FBS
In a simple cash
system users are able to record all cash transactions of both the farm and
family. Quicken is the only program listed, due to its widespread use
across the U.S. Its popularity is due to the ease of data entry and to its low
price of $30 to $100. This single-entry system is essentially an electronic
checkbook. However, it allows users to track loans, stock portfolios and other
financial assets. The ability to easily enter data, write checks from the
computer, reconcile the checkbook with the bank statement and quickly create
reports for financial and tax purposes explains its broad acceptance. There is
a payroll module that can be added which is adequate for the firm with only a
few employees.
Critics of Quicken
point to producers with limited knowledge of accounting concepts who fail to
properly classify income and expense entries that lead to flawed reports.
Quicken does not have a chart of accounts with income and expense categories
specific to agriculture. Users can correct this problem by contacting Extension
agents for training and obtaining a sample chart of accounts to use with their
farm records. Others fault Quicken for the lack of fields to track physical
quantities. But properly used, Quicken can provide useful, accurate summaries
of all cash transactions, including sales and purchases of capital assets such
as machinery and breeding livestock. Once the depreciation schedule is created,
not by Quicken, producers have all data needed for tax reporting.
Three programs are
listed under general cash/accrual accounting systems. QuickBooks is
representative of this group. QuickBooks has an excellent chart of accounts
specific to agriculture. Reconciliation of computer accounts with bank
statements is quite easy. Double-entry features allow either cash or accrual
reports. Firms with employees enjoy the ease of generating payroll checks and
all related employee reporting. The user begins by entering a beginning cost
basis balance sheet. As daily receipts and expenditures are entered, the
balance sheet is updated. But unless the user also records transfers of feed
from inventory to livestock, monthly depreciation, etc. the intra-year balance
sheets are not correct. For farm users a balance sheet once a year is typically
all that is useful and necessary. This is accomplished by taking a year end
inventory and entering the adjustments, including depreciation to make the
year-end balance sheet. The beginning and ending balance sheets, plus cash
receipts and expenditures give the user an accrual Income Statement, thus
providing your basic financial statements.
Use of a program such
as QuickBooks does require some knowledge of accounting. Again, these are
general accounting programs and may not allow for recording physical
quantities. There are some training materials and Web sites that can assist
producers who wish to use such programs. Like Quicken, it allows you to
separate the data into enterprise groups, such as dairy versus crops. In order
to produce accurate financial statements, only information relating to the farm
business should be recorded. If a computer is used to track family income and
expense, you should have separate checkbooks and use Quicken to record all
nonfarm transactions. While more expensive than Quicken, the $100 to $300 price
tag is still attractive to many small businessmen, including farmers.
The third group is
farm cash/accrual accounting systems. These systems have accounting
packages specifically tailored to a farm business. Because they are farm
specific, they contain a chart of accounts which minimizes mis-classification
of data. Reconciliation with bank accounts, payroll modules and ability to
record and use physical quantities in reports are available in all packages.
FBS and Red Wing have additional modules that can be purchased for
special reports, depreciation, etc. These reports are also integrated, i.e.
they share data among programs. The availability of various modules allow
producers to upgrade to a more comprehensive system as they grow or desire more
information.
The farm cash/accrual
accounting systems require some knowledge of accounting. Most focus only on
the farm business, but some allow family or other business data to be kept in
the same system. For example, FBS's TA+ uses Profit Centers to sort data for
reporting purposes. The cost can range from about $200-300 for PCMars or
Smart Start from FBS to $2,500 or more, depending on what add-on
programs are selected. The cost of the software may be insignificant if you end
up getting accurate useful information for decision making results. Trying to
totally integrate many programs, especially the integration of feed produced,
purchased, fed and sold with all cash transactions, can be a daunting task. By
starting with the basic program, and adding others as needed, major problems
should be avoided.
All accounting
software programs discussed above allow checks to be written with the computer
as the data are entered. All allow for reconciliation of accounts with bank
statements. This is a major step in improving the accuracy and completeness of
farm business records. Reports can be tailored to the needs of the tax
preparer, accountant and manager.
The major
disadvantage, for some is that they all require use of a computer. Persons of
all ages can learn to use the computer and do it well. A by-product of printing
checks from the computer is that the user is forced to enter the bills as they
arrive, checks can be printed later. By using the computer just as much time is
spent keeping records, but records will be of more benefit. To learn the system
and to get accurate, useful records data entry must be done each week.
Any of the above types
of record systems can get annual summaries of cash receipts and expenses. This
includes sale and purchase of capital assets, principal and interest payments
and additional borrowings. To obtain financial statements and analyze financial
position requires using the data in a separate program. This may be an
additional module from the software company, or it may be a separate program.
In either case, the chart of accounts used must match up with the grouping of
income and expense categories in the other program.
Spreadsheets are
available that can be used with year end inventory data to develop balance
sheets, income statements and analysis. See the Montana State University Web
site, [http://www.montana.edu/wwwextec],
for ones currently available. Little cash outlay is required, but you will need
to spend time to understand how to collect and enter the data to do it right.
The publication on AFRA has detailed examples on how to collect and value
inventory, prepare financial statements and analyze the reports (Oltmans, et.
al., 1992). While much of the focus in the AFRA manual is on dual column
balance sheets, this publication can be helpful developing business financial
statements.
FINPACK provides
another way to develop and analyze financial statements. Many extension agents
and FBPA instructors can work with users to collect the data and interpret the
results.
The third alternative
is to use a program that is integrated with the basic software like TA+ or Red
Wing. In addition, the AFRA program from FBS can be purchased as a separate
stand-alone program for about $400 and used with annual totals from any of the
accounting packages to create and analyze financial statements.
No one can predict
which program is best. The following may help in the decision.
Examine farm specific
programs if you:
Examine cash-based or
generic programs, e.g., Quicken, if you:
Any system can get the
needed cash receipt and expense data. However, to get useful financial
statements, an inventory must be taken at the end of each business year.
Without this, it is impossible to develop accurate balance sheets and income
statements.
Farmers who need
accurate, complete financial statements and analysis should consider using some
form of computer record system. Such statements can be prepared using a simple
cash only system like Quicken when used in conjunction with spreadsheets, other
software programs such as FINPACK or the AFRA program by FBS, or in conjunction
with an accountant.
Others who have some
accounting knowledge may use more sophisticated computer programs, such as
QuickBooks or Transactions Plus from FBS, that can produce the financial
statements and measures directly. However, even these accounting programs are
often used in conjunction with other software programs or an accountant is
hired to develop the financial statements and analysis.
Regardless of the
record keeping system a producer chooses, annual inventories must be taken at
the end of each business year to develop accurate and complete financial records.
Each producer must determine what they can or want to do, and what they want to
hire others to do.