CHAPTER THREE

ANALYSIS OF FARM RECORDS AND

ACCOUNTS
 Farm Records

OBJECTIVE

 Define farm records.

 Define farm record.

 Explain type of farm record

 Describe Measures of Financial Success and Capital

Position.
 Key terms:

 Farm accountancy is defined as the art and as the science

of recording business transactions in books in a regular and
systematic manner so that their nature, extent and
financial effects can be readily ascertained at any time of
the year.
 Farm Book Keeping(clerking) is known as a system of
records written to furnish a history of the business
transactions, with special reference to its financial side.
 Farm accounting, in the usual sense is an application of the
accounting principles to the business of farming.
 The following are the three major steps or
stages of farm business analysis:

 Keeping proper recording of accounts and

activities;

 Analysis and interpretation of results; and

 Presentation of results.
 The main objectives of farm business analysis
are to answer such questions as:

 How does the business perform at a certain

time;

 Where are the weaknesses; and

 What improvements are possible?

 FARM RECORDS

 Is the information recording process on the day-to-day

operations of a particular farm.

 Are the written records or documents of various activities

carried out on the farm on a daily basis.

 Types of Farm Records

 There are different types of records that are

important for decision-making.

 And there is no single widely accepted design for farm

record.
 However any farm record has to provide the most
important requirements such as: simplicity, specificity,
ease of accessing information, and comprehensible to
another user.

 There are three parts of a farm record system:

1. Physical farm records;

2. Financial farm records, and

3. Supplementary farm records

 There Are three Kinds Of farm Records

A. Physical records – Show the production of crops and livestock and

the usage of inputs.
Example;
Crop yields,
livestock births,
hectares planted,
Tones harvested, etc.
B. Financial records – Include receipts and expenses and will give;
1. the net worth statement,
2. The income statement &;

3. The cash flow statement/summary.

 There Are three Kinds Of farm Records

A. Supplementary records: are about Function to a

supporting capacity

• Includes:
 Sanction register

 Rainfall register
 Stationary register
 Auction register
 Hire register
 Farm Records

Some important farm records are

Inventory Income or
Receipts Home
Records Records Consumption
Record

The Crop and Durable

Farm Assets
Livestock
Expenses
Labour Depreciation
Record Record Record:
A GOOD FARM RECORD SYSTEM SHOULD:

 Provide necessary, accurate and updated

information;
 Be legible, readily accessible and user-
friendly;
 Be flexible enough to provide information in
a variety of ways
 Be readily understood and audited.
FARM ACCOUNTING
 Accounting is a set of concepts and techniques that are
used to measure and report financial information about an
economic unit.
 Farm Accounting: is the systematic way of recording
financial business transaction (what the farmer spends or
receives on the farm).
 Are designed to show two major financial statements.
 First is the capital position or net worth of the farm
i.e. balance sheet.
 Second is the profitability of the farm business (the
income and expenditure i.e. profit or loss).
FARM ACCOUNTING
 Accounting is the process of recording, summarizing, analyzing,
and interpreting financial (money related) activities to permit
individuals and organizations to make informed judgments and
decisions are generally not reported on an external basis.
 Financial accounting is concerned with external reporting of
information to parties outside the firm.
 Managerial accounting is primarily concerned with providing
information for internal management.
 Financial accounting: Consider that financial accounting is
targeted toward a broad base of external users, none of whom
control the actual preparation of reports or have access to
underlying details.
PROBLEMS AND DIFFICULTIES IN FARM ACCOUNTING
 Subsistence nature of farming

 Farming is a laborious work

 Triple role of farmers

 Illiteracy and lack of business awareness

 Complicated nature of agribusiness

 Inadequate extension service

TYPES OF FARM ACCOUNTS

• The most common financial farm accounts include:

1. Balance Sheet

2. Income Statement

3. Cash Flow Summary

 1. Balance Sheet (net worth statement )
• Shows the capital position of the farm enterprise (the value of
farm assets) at a given point in time (usually at the end of the
year) .

Net worth = Assets – Liabilities

Divided into:

a) Assets: Anything of value owned by the farm business.

 (current (or liquid), working and fixed assets)

b) Liability: legitimate claims made against the farm business.

 (current, intermediate and long-term liabilities)

c) Net worth: the absolute equity/ the amount by which assets in

the business exceed its liabilities.
 1) Assets
• Assets are items which the business owns or can
use to acquire more items e.g. cash, car,
building, machinery and land.

 An asset has value for one of two reasons:

1) It can be sold to generate cash, or

2) It can be used to produce other goods

that in turn can be sold for cash in the
future.
 a) Current (liquid)assets

are assets that are easily converted into cash.

 They include;

 cash,

 accounts receivable,

 Inventory (grain and market livestock) easily

converted into cash or consumed within 1yr
 b) Intermediate or working assets

 are assets which are used up within the

production process of the business.

 Are held and used for several years.

 E.g. breeding stock, equipment and machinery

 They have a life expectancy >1 year < 10

years.
 c) Fixed or long-term assets

• are assets which cannot be easily

converted into cash to meet current
obligations.

• have a useful life > 10 years

• E.g. land, buildings and other others.

 liabilities
• represents an outsider’s claim against a farm
business enterprise.

 is an obligation or debt owed to someone else.

• Examples: loans and credits, mortgage in farm,

unpaid bills, etc.

• Three classes of liabilities;

i. Current liabilities;

ii. Intermediate liabilities and ;

iii. long-term liabilities

 i) Current liabilities (CL)
 Are financial obligations that will become due and
payable within one year from the date on the balance
sheet.

• Examples:

 accounts payable,

 principal and accrued interest on short-term

loans to be paid immediately and;

 principal due within one year on longer term

loans.

• Are general used to finance the production inputs.

 II) Intermediate liabilities (IL)

• Are obligations deferred for the time being but will

be paid within a few years (>1 and < 10 years),

• Examples;

 promissory notes,

 obligation based on crop/livestock in the

process of production.

• Are used to finance the working assets such as

breeding livestock, equipment and machinery.
 III) Long term liabilities

• Are liabilities that will not due within a short

period of time.

• They will due in a period of > 10 years

• E.g.; real estate mortgages and long term land

leases.

• Are used to finance the most permanent assets,

such as land and buildings.
 Purpose and Use of a Balance Sheet

• Systematic organization of everything “owned”

and “owed”

Assets = liabilities + owner equity

Owner equity = assets  liabilities

• Most prepared at end of accounting period

• Provides measures of solvency and liquidity

25
Example of Balance Sheet Statement as of December
31st, 2009
Current 56,400 Current 54,900
assets liabilities

Noncurrent 478,000 Noncurrent 173,000

assets liabilities

Total assets 534,400 Total liabilities 227,900

Net-worth 306,500

Total liab. and

Net-worth 534,400
26
 2. Income (Profit/loss) Statement

• It is the statement which presents the

difference between the gross receipt and total
cost of production.

• is a summary of revenues and expenses as

recorded over a period of time.

= Gross receipt - total cost of production

• is the surplus resulting from business operations

 Income Statement

Divided into:
a) Gross receipt: Also called the TVP= TPPx price per unit
of produce
b) Total cost: amount incurred in the use of inputs in the
production process.
i. Fixed cost: Costs that do not vary with output in
SR
ii. Variable cost(operating cost): vary with levels of
output.
c) Net farm income: TR(gross receipt) - TC
Inputs Value Outputs Value
Variable costs Income Sales and receipts
Statement Format
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
= 2,764 – 940 + 206 30
 3. CASH FLOW SUMMARY

• is a financial report that describes the

source of a company's cash and how it was
spent over a specified time period

A historical record of monthly cash inflows

and outflows usually for one year.
 Formats of CFS

• CFS has 3 sections;

1. Cash inflow

2. Cash out flow

3. Net cash flow

 The cash flow statement is intended to:
1. Provide information on a firm's liquidity and
solvency and its ability to change cash flows in
future circumstances

2. Provide additional information for evaluating

changes in assets, liabilities and equity / to assess
its ability to meet its obligations to service loans,
pay dividends etc

3. Improve the comparability of different firms'

operating performance by eliminating the effects
of different accounting methods
 To sum up,
• If you have a list of records and statements are available,
proper farm analysis can be carried out by:

1) Comparing past records with the present and look for

progress in the business.

2) Comparing volume of production and cost of production.

3) See areas where problems have occurred in the past

(costs have risen) and consider how they could be
lowered.

4) Identifying whether or not financing is required.

 Farm Business Analysis
• From our previous discussion, the purpose of keeping
records is not just to accumulate masses of information.

• It is to use this information to compare and discern

trends in the farm business.

• These trends help farmers make sensible managerial

decisions:

• Is this enterprise profitable?

• Can I afford to purchase a new tractor?
• Should I change my enterprise mix?

• Records are useful only it they are used.

 Farm Business Analysis

• Entails the use of various ratios and indicators

taken from the financial statements.

• A series of these figures over time shows where

the business is heading towards and helps us

make decision to alter course.

 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.
 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 labor, management, land and capital and
three ratios (gross, operating and fixed) which are also obtained
from the net income statement.

38
 Measures of Financial Success
 Entails the use of various ratios and indicators taken from
the financial statements.
 A series of these figures over time shows where the
business is heading towards and helps us make decision to
alter course.
 Thus, there are 4 basic categories of financial analysis:
1. liquidity,
2. solvency,
3. profitability and
4. efficiency.
 Liquidity
 Liquidity: refers to how quickly and cheaply an asset can be
converted into cash.

 Liquidity measures the ability of the farm business to

meet financial obligations as they come due, without
disrupting the normal, ongoing operations of the business.

 It means the farms ability to meet cash obligations

without disrupting the normal operation of the farm.

 Working capital, Debt structure Ratio and

Current ratio are common measures of liquidity
 A. Current Ratio
Current asset (CA)
Current ratio =
Current liability (CL)

 CR=1. CA= CL. Although there are sufficient current

assets to cover current liabilities, there is no safety
margin.
 CR>1. CA> CL. There is a safety margin that allows
for price and other changes.
 CR<1. CA<CL. The farm is less liquid (liquidity
problem)and the risk is greater

 The higher the ration, the more liquid the farm’s

liquidity position 41
 B. Working Capital

Working capital = Current assets  current liability

Working capital = $112,500  $88,860 = $23,640

 Shows what is available after meeting debts due.

 We need a positive figure, otherwise the firm is

illiquid.

 The higher the working capital, the better b/c the

company is generating a lot of sales compared to
the money it uses to fund the sale
42
 C. Debt structure Ratio (DSR)

Debt structure ratio = Current liabilities

Total liabilities
• A ratio of 0.6 means that 60 percent of the total farm
debt is due the following year.

• If total debt is small, there is nothing to worry about.

• A DSR of 0.6 shows that too much of the farm debt is

current

• In general,
 a ratio of ≤ 0.2 is safe;
 A ratio of ≥ 0.5 more is dangerous.
 D. Quick Ratio (acid test ratio)

Quick Ratio = Current assets – inventory, supplies,

growing crops
Current
liabilities

• A QR around 0.5:1 is probably reasonable

• If QR < 0.3 the farmer has a lot of inventory and will

have to take current market prices in any forced
sale.
 2) Solvency (Leverage) Ratios
 Refers to an enterprise’s capacity to meet its long-term
financial commitments.

 Measures the liabilities of the business relative to the

amount of owner equity invested in the business.

 It provides an indication of the ability to pay off all

financial obligations if all assets were sold.

 A solvent firm is the one that owns more than it

owes(POSITIVE NET-WORTH)

 If assets are not greater than liabilities, the business is

insolvent.

 Indicators are networth, the leverage ratio and the

solvency ratio.
45
 2) Solvency (Leverage) Ratios

 Refers to an enterprise’s capacity to meet its long-term

financial commitments.

 Measures the liabilities of the business relative to the

amount of owner equity invested in the business.

 It provides an indication of the ability to pay off all

financial obligations if all assets were sold.

 A solvent firm is the one that owns more than it

owes(POSITIVE NET-WORTH)

 If assets are not greater than liabilities, the business is

insolvent.
 Indicators are networth, the leverage ratio and the
solvency ratio. 46
 i) Networth

• So the basic solvency indicator is net worth

• We are obviously looking for a positive

figure.

• A negative networth shows insolvency.

Networth = Total Assets – Total liabilities

 ii) Leverage (Debt/Equity) Ratio

Leverage Ratio = Total Debt

Networth
• Most lenders do not want to see leverage ratios over 1.5:1.

• B/c there is 1.5 Birr of debt for every 1 Birr of net worth.

• The higher the ratio, the more risk the firm faces and vice..

 Shows the degree of financial leverage being used by

the business (short and long term debt)

 The higher the ratio, the higher interest expenses

 iii) Solvency (Debt/Asset)Ratio
Solvency = Total debt
Total assets

• Measures the % of a company’s assets that have been financed

with debt (short and long term)

 The higher the ratio, a greater degree of debt/leverage and

consequently, financial risk

 The higher the ratio, the more debt there is for each Birr of
assets.

 Number close to zero is better, b/c more assets were paid for
w/o debt
 3) Profitability
• Three main indicators of profitability (income statement):
1) Net farm income, 2) off – farm income and 3) Net
Income

A. NET FARM INCOME = Total farm Revenue – Total

farm cost

B. OFF-FARM INCOME = comes from non-farm jobs and

custom work on other farms

C. NET INCOME = net farm income + off –farm income -

all income taxes and social security payments due on these
income sources.

• Net income is the real bottom line of a business and is the

single most important indicator of profitability.
 3) Profitability
 Profitability refers to the difference between income
and expenses.

 One important measure of profitability is net farm

income.

 Profitability measures the extent to which a business

generates a profit from the factors of production: labor,
management and capital.
 Ratio indicators

• The remaining measures of profitability are all

ratios.

• These are;

a. Value of Farm product (VFP)

b. Net farm income (NFI)
c. Rate of return on assets (ROA)
d. Rate of return on equity (ROE)
e. Operating profit margin
 a) Return on Assets (ROA)
• It is a measure of profitability, measuring the rate of
return that the farm business earns on its average
asset over the period,

• The higher the return, the more profitable the farm

business

Return on Asset = Net farm income + interest expense – labour X 100

Total farm Assets (average)
 b) Return on Equity (ROE)
• It is a measure of the return to the networth (equity) in
business.

Return on equity = Net farm income – labor X 100

Farm equity (average)

• The farm equity is the capital that could be invested

elsewhere (if you are not farming) and

• Used to compare a return you are receiving on your

investment in farming as with other alternatives
 c) Expense /Return Ratio

• Shows the percentage of the farm income that is

required to cover the operating expenses, excluding the
principal and interest payments.

ERR = operating expenses X 100

Value of farm production 1

• The TVP is the total value of farm sales less the cost of
purchased feeds, grain and market livestock.
Thus,

• All these profitability measurements

provide information on how well the business
is doing,

• but they do not show whether the resources

are used efficiently.

• This is where the final set of indicators

comes in.
 4) Efficiency Measure
• Efficiency basically measures the relationship
between inputs and outputs.
• They can be divided into physical and financial
measurements.

A. Physical measures
• The commonly used physical measures are: yield
per hectare, yield per animal in terms of births,
outputs and herd life; kilogram of feed per
kilograms of live-weight gain and other conversions
factors.
• These figures come from the basic physical
records of the business.
B. Financial Measures
• The financial measures of efficiency are all ratios
and these include: the operation ratios, the debt
service ratio and the times interest earned ratio.
Thank you!