UNDERSTANDING ACCOUNTS
UNDERSTANDING ACCOUNTS
By Trevor Reade and Sasha Cowan
EVERY farmer will be familiar with the annual task of preparing accounts and in most cases the associated tax returns. But is that the best way to monitor the financial status of your business?
Probably not. Such accounts are prepared according to general accounting principles, normally cover a twelve month period and are produced primarily for taxation purposes. As a management tool they are of limited value.
That is why management accounts are being used more widely to more accurately measure the performance of a farming unit. The main differences are the period of time assessed and the way stock is valued.
Timing
Some enterprises have production cycles that do not fit into an annual reporting model, such as double cropping vegetables, which will give two profit streams from one piece of land in a twelve-month period.
Furthermore, production cycles may not fit the annual reporting timetable. A March or April financial year-end covers two different periods of cropping.
Management accounts covering the whole of a production cycle give a much better picture of the results of an enterprise than annual accounts prepared for taxation purposes.
Valuations
Stock in financial accounts is normally valued at cost, in accordance with Inland Revenue guidelines. The basic principle is that the accounts will only show the profit generated by an enterprise after the crop is sold.
For management accounting purposes all stocks are shown at market value and the profit shown is therefore the true profit of the enterprise.
In financial accounts the profit generated by an enterprise and its contribution to the annual profit shown can vary due to differences in the timing of sales. That problem is overcome with management accounts.
Furthermore, financial accounts record profits for taxation purposes and may not fully reflect the actual picture. Variations between different farms may result from accounting procedures not the relative performance of each enterprise.
Benchmarking
When assessing the performance of different units it is useful to compare results against other similar operations. Such benchmarking, where comparisons are on a "per unit of output" basis allow units of differing size to be judged against each other. On an arable unit cost per tonne or per acre may be a suitable measure.
Financial health
In order to judge the financial health of a business it is necessary to consider three factors:
• Profitability – this should be judged on the management accounts to give a true picture.
• Liquidity – does the business have the necessary cash available to fund it, either from existing reserves, agreed borrowing limits or new facilities?
• Return – is the business able to generate a sufficient return to make it worthwhile?
Profitability can be benchmarked against comparable data over a number of holdings.
Available cash can be assessed by looking at the requirement for liquid funds over the next two to three years by way of a cashflow forecast. Remember that if additional borrowing is required the cost will impact on the profitability of the enterprise. Lack of working capital is a common problem in agriculture, even more so in recent years.
If an enterprise is to be worthwhile it has to provide the farmer with an adequate return. This is measured by assessing the return on capital employed in the business.
Many agricultural businesses show a low return on capital, mainly due to a large asset base. While such low returns may be acceptable, each individual case needs to be examined.
A business can only be said to be in a healthy state if it can be shown to be profitable, generating sufficient cash and providing an adequate return to the farmer.
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Getting to grips with farm accounts and business monitoring is vital if hard won cereal yields are to convert into a worthwhile profit.
Farming income for arable enterprises (£/ha)
Top 25% Average Bottom 25%
Total farm gross margin 702 596 551
Fixed costs
Labour 136 141 210
Power and machinery 84 62 74
Machinery depreciation 74 82 79
Property 35 42 40
Administration/other overheads 84 77 106
Total fixed costs 413 404 509
Management profit 289 192 42
Rent 62 77 59
Finance 22 7 2
Net farm income after rent and finance 205 108 -19
Other income 54 40 104
Profit/loss on sale of assets 2 -5 12
Total farm income 261 143 97
NB: Average arable farm size of 360ha.
BENCHMARK COMPARISONS
Benchmarking can help compare farm business performance with similar businesses within a region and further afield.
Strutt & Parkers benchmarking has helped confirm which management issues really need addressing. The crucial importance of crop yield and price compared with overhead cost control is one example.
By benchmarking the financial performance of Strutt & Parkers managed farms on a national basis and the yield performance of managed farms and agronomy clients in East Anglia some important points emerge:
1 The most profitable farms tend to be those that can produce the highest farm gross margin.
2 Reducing fixed costs is important and undoubtedly economies of scale do help to do this. But the figures show yield and price remain the key to arable farm profits.
3 Yield league tables for East Anglian farms show that farms producing the top yields also tend to be in the top 25% for profitability.
4 Sundry income or other income is becoming increasingly important to maintain farm profits. But this relies heavily on location. It appears that the farms nearer to London and the South East can provide distinctly more other income than those elsewhere.
5 Yields dropped off quite dramatically between 1999 and 2000, particularly for the farms that achieved the highest yields in 1999. A lack of sunlight is thought to be one of the main reasons. However, those with lower yields in 1999 saw hardly any yield reduction in 2000.