Enterprise Accounting: Key Questions Chapter 18 How are enterprises defined? How are income and...
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Transcript of Enterprise Accounting: Key Questions Chapter 18 How are enterprises defined? How are income and...
Enterprise Accounting:Key QuestionsChapter 18How are enterprises defined?How are income and expenses
allocated by enterprise?How are internal transactions
made?
Divide Farm into Enterprises(profit centers)
Commodity corn, alfalfa, beef cows, sheep
Stages farrowing, nursery, finishing
By production cycle (crop year) Cost Centers (machinery, labor)
Assign Income and Expenses1. Use account codes to assign direct
income and expenses Seed corn 631 Soybean seed 632 Alfalfa seed 634
2. Allocate “overhead” expenses among enterprises
By % of gross income By % of other expenses By acres
3. Include Internal Transactions
raised feed from crops to livestock
manure from livestock to crops
machinery services do not affect whole farm
income or expenses
4. Include inventory changes or other accrual adjustments if you summarize by accounting year
5. Not necessary by production cycle
Profit and Loss Statement for Farmsim
Income Total Crops Hogs Cattle
Sales $421,473 $49,117 $105,427 $266,929
Ins payments 0 0
Inventory chg -46,297 21,650 1,653 -69,600
Gross income 375,176 70,767 107,080 197,329
Feed purchased -77,013 0 -42,323 -34,690
Raised crops fed 0 30,642 -10,843 -19,800
Livestock purch -94,000 -1,600 -92,400
Value farm Prod 204,162 101,409 52,314 50,439
Verifying Inventories: Crops
Sources =+ Beginning
inventory+ Purchases+ Production
Uses Ending
inventory Sold Fed Spoilage Used for seed
Verifying Inventories: Livestock
Sources =+ Beginning
inventory+ Purchases+ Production+ Transferred in
Uses+ Ending inventory+ Sales+ Death loss+ Transferred out
Farm Business Analysis—Ch.18
What are the strengths and weaknesses of the farm business?
How can we measure how well the farm is doing?
Which farm would you prefer?
Farm A Net worth $200,000 Labor 12 months Net income
$30,000
Farm B Net worth $400,000 Labor 24 months Net income
$50,000
What Affects Net Farm Income and Cash Flow?
SizeEfficiency
Size or Scale of the Farm
Resources
Acres
Cows or sows
No.of layers
Total assets--$
Number of workers
Production
Pigs sold
Cattle fed out
Bushels sold
Lbs. of milk
Gross sales--$
Efficiency = production per unit of resources
Physical efficiencybushels per acrelbs. milk per cowpigs per sow per yearlambs per ewepounds of feed per lb. of gain
Economic Efficiency(value of product per unit or $
of resource)Crop value per acre--$Asset turnover ratio--%
= gross income / total assetsLivestock returns per $ of feed Gross income per person (FTE)
Economic efficiency also depends on:
Value of Product (marketing)
Sale priceQuality TimePlace
Cost of ResourcesSeed, chemicalsCash rentMachinery, fuelWagesFeed
Economic Efficiency
= Units of output x selling price
Units of resource x purch.price
Ex.: crop value per $ rent paid
160 bu. corn x $2.25/bu. price
1 acre x $145 per acre
= $2.48 per $1 spent on rent
Economic EfficiencyPhysical efficiencyMarketingCost of resources
Standards of Comparison
BudgetsHistorical records for the same
farmCurrent records from comparable
farms
Choosing the Right Enterprises
Fit the locationFit the operatorFit the resources
Net Farm Income also depends on how many of your resources you contribute yourself.
Operator labor instead of hired labor.Net worth capital instead of debt.Owned land instead of rented.Net Farm Income is a return to
operator labor, net worth and management.
Financial Structure
SolvencyLiquidityProfitability
SOLVENCY: Comparing assets to liabilities
Net worth - $
Debt-to-asset ratio (or other ratio)
Debt-to-asset ratios of 30 % to 40 % are typical, though many farms have no debt.
LEVERAGE: degree in debt
Total debt-to-asset ratio
<---10%-------20%--------40%------60%-->
low average high
High rates of profitability or low interest rates allow higher leverage to be sustained.
Liquidity(having cash when needed)Current ratio = current assets
current liabilities
Working capital =(current assets - current liabilities)
LIQUIDITYCurrent ratio should be 2.0 or better
Farms with continuous sales can have 1.5, but farms with infrequent sales may need 3.0
Working capital typically equals 25 % to 35 % of annual gross revenue
Dairy may be as low as 20% of gross revenue, cash grain as high as 50%
Profitability (income and expenses)
Net farm income value of unpaid labor ($/year) interest on owner equity (% interest rate x net worth)
= Return to managementThese are opportunity costs
Example
Net farm income
- value of unpaid labor (15 months @ $2,000)
- value of owner equity ($300,000 net worth @ 5%)
= Return to management
$65,000
$30,000
$15,000
$20,000
Profitability--% Return on Equity--%
= (NFI – unpaid labor) / farm net worth Return on debt capital (interest)
Interest paid for the year / total liabilities Return on Assets--%
(NFI – unpaid labor + interest expense paid)
Total farm assets
ROA is an average of ROE and the interest rate.
PROFITABILITY
Return on assets (ROA)
<---0%-------4%--------8%--------12%--->
low average good
Return on Assets--Iowa
8.4
5.0
6.0
3.73.2
7.57.0
5.8
-2.1
1.7
6.0
2.3
4.7 4.7
5.9
-3.0
-2.0
-1.0
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04
%
Return on Assets to High Third and Low Third Farms in Iowa
-15
-10
-5
0
5
10
15
20
94 95 96 97 98 99 00 01 02 03 04
%
High Third
Low Third
Other ratiosGross revenue can be divided into:
operating expense (60 to 70 %)
depreciation (5 to 10 %)
interest (5 to 10 %)
net farm income (15 to 20 %)
High profit farms may keep 25 to 30 % of their gross revenue as net income
FINANCIAL PERFORMANCE MEASURES
1. Compare to similar farms.
2. Look at trends over several years.
3. Supplement ratios with production data and enterprise analysis.