Three Financial Records to Help You Make Better Decisions
When it comes to record-keeping, there is a general feeling of dread caused by the idea of having to account for every little detail. While this is an understandable feeling, you should never fear your own records. Record-keeping provides us the opportunity to take a look at where we've been and where we are currently. By building this roadmap, the past can be assessed to build a plan for the future. This is especially true when it comes to financial records. But how detailed should these records be? As an economist, I want to track where every penny is spent and what I'm getting back for spending it. To me, the more detailed, the better. Financial records can provide a wealth of information, but only if they are complete and understood. At a minimum, sufficient income and expense records should be kept in order to file an accurate tax return. Any additional information should be kept with the intention of using it to make management decisions. You could have the most complete set of books around, but the extra work of keeping those records will have been for nothing if you're not using that information.
There are many different methods and tools available for keeping financial records. No one method is right or wrong. These can be as simple as handwritten records, but with today's technology, a majority of these are computer-based programs. Programs such as Quicken and QuickBooks have the ability to securely import banking transactions and categorize them, which allows for fast and easy analysis and reporting.
Whichever method you choose, there are three statements that should be kept: a net-worth statement (also referred to as a balance sheet), an income statement and a cash-flow statement. Depending on the statement, areas of performance can be measured. Each one provides indications on its own, but even more information can be obtained by using all three together.
1 Cash-flow Statement
A cash-flow statement is a tool used to track financial obligations and when payments are received. Think of this as the checkbook ledger for your operation. By tracking the cash availability, you can establish a budget or annual plan to provide the opportunity to evaluate if or when capital investments can be made. This is the same principle that should be used with personal finances. Monthly and annual budgeting are both highly important when it comes to making financial decisions.
2 Net-worth Statement
It's a good idea to complete an updated net-worth statement at the beginning of each year. This gives you a snapshot of where you currently are financially. A net-worth statement consists of two lists: assets and liabilities. Assets are everything that is owned or owed to the operation through owner equity and/or borrowed equity. Liabilities are what the operation owes. The net worth statement is used to determine the liquidity and solvency of the operation by looking at different ratios. Decisions regarding borrowing capital can be made by keeping track of these ratios.
3 Income Statement
The income statement provides a look at the profitability the operation. There are two types of accounting systems used on income statements:
Entries are made for expenses and incomes when money changes hands.
Records changes in inventory, income that has been generated but not received (accounts receivable), and expenses that have been incurred but not yet paid (accounts payable).
Both are acceptable methods of record- keeping. However, accrual accounting is more accurate at keeping a realistic view of the businesses finances.
A common misconception about income statements is that an IRS Schedule F and an income statement are the same thing. While they are similar, an income statement should be an itemized list that can be broken down by enterprises. This is where computer programs can come in handy. Incomes and expenses can be tagged or categorized based on what enterprise they were used for. Example: a cow-calf producer participates in a preconditioning program before selling calves. Without allocating the sales, cull cows and bulls would be combined with the sales of the calves. Unallocated expenses would be added together for all the livestock. This would prevent determining how profitable each enterprise was. By keeping detailed records, an operator would be able to compare the profitability of the cow-calf enterprise to the profitability of the preconditioning enterprise.
Not all operations will need this level of detail. Simple totals that are reported on the Schedule F may be enough for an operation, but that operation should not expect to be able to calculate the cost of feeding a steer during a preconditioning period. Without that ability, considering alternatives can become challenging. By keeping detailed records, evaluating what your expenses are and how much you are spending on each can have a large impact on managing costs. In the current market, this should be a priority for producers.
5 Financial Health Indicators
There are five areas of financial performance that provide a look at the health of your operation. The Farm Financial Standards Council defines each of these as:
The ability of your farm business to meet the financial obligations as they come due, to generate enough cash to pay your family living expenses and taxes, and to make debt payments on time.
The ability of your business to pay all its debts if it were sold tomorrow. Solvency is important in evaluating the financial risk and borrowing capacity of the business.
The difference between the value of goods produced and the cost of the resources used in their production.
4. Repayment Capacity
The borrower's ability to repay debts on time. It includes nonfarm income, so it is not a measure of business performance alone.
5. Financial Efficiency
Shows how effectively your business uses assets to generate income. Past performance of the business could well indicate potential future accomplishments. It also answers: Are you using every available asset to its fullest potential? What are the effects of production, purchasing, pricing, financing and marketing decisions on gross income?
Find more financial performance tips at noble.org and The Farm Financial Standards Council.