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
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.