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Important financial numbers for dairies (Proceedings)

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Aug 01, 2010

With the current economy, everyone is becoming increasingly interested in discussing financial numbers with farms. However, the numbers do not tell the whole story. It is important to determine the goals of the farm prior to jumping into evaluating the numbers. The goals of the farm may be drastically different than the farm down the road, and their financial goals may be extremely different. For example, one farm may be interested in expansion because their son/daughter has decided to return home to run the family farm. Or the farmer has decided that he is interested in retiring and spending the rest of his life taking trips to visit the grandchildren. Both of these farms interest in their financial numbers are drastically different.

As veterinarians, we have been trained to look at production numbers, somatic cell counts, pregnancy rates, and many others; however we rarely get the opportunity to look beyond production to the actual financial numbers of an operation.

To begin a financial evaluation it is first important to determine where the farm is at this point in time. Otherwise, we are unable to make predictions or suggestions regarding the direction the farm would like to go. The overall financial status of farm is best determined by looking at three financial statements: statement of cash flows (including withdrawals and non-farm income), income statement (on accrual basis), and balance sheet with assets valued at costs and market value.

Cash flow statements are important because they help to determine is their adequate cash available to service debt obligations, pay owner, etc. The cash flow summary can be determined by determining net cash from operations (operating income minus operating expenses), net capital (capital asset sales minus capital purchases), net loans (new loans minus principal repayments), and net non-farm cash (non-farm income minus non-farm uses of cash). This is the best measure to determine in-flow and out-flow of cash for the farm.

Balance sheet (net worth statement) determines the present condition of a business at a set point in time. This statement is based on the equation: Assets = Liabilities + Equity. Assets examples include such entities owned that have value including cash, equipment, land, cows, and buildings. For the balance sheet, it is important to determine assets based at cost and fair market value to get a true determination of what is occurring on the farm. Liabilities are any obligations of an entity to transfer assets to or perform services for. Examples of liabilities include loans on equipment or cattle. Equity is defined as the difference between assets and liabilities. Equity is sometimes referred to as net assets, and it is one of the best measurements of solvency for the farm.

Income statement provides information about an entity's financial performance during a specific time period. The income statement equation is based on the equation: Revenues – Expenses + Gains – Losses = Net Income (or Net Loss). Revenues are increases in net assets that occur from selling products (milk, replacements, etc). Expenses are defined as sacrifices of future value of assets used to generate revenue (e.g., purchased feed). Gains are defined as increases in net assets (equity) that result from incidental or peripheral events (e.g., calves born). Losses are defined as decreases in net assets that result from incidental or other peripheral events (e.g., cow deaths).

Since there are no "Generally Accepted Accounting Principles" for farm businesses, it has been difficult to make comparisons between different farms. With the advent of the Farm Financial Standards Council, a more standardized (but not perfect) method of reporting is being adopted by farm lending institutions, accountants and others. These criteria are known as the "Sweet 16" financial measures that most lending institutions use for evaluating financial fitness of a farm business. In this economy of failed lending institutions, more institutions are looking for some measure of confidence that the borrower will be a relatively low risk to repay both principal and interest.

The areas covered in the "Sweet 16" include liquidity, solvency, profitability, repayment capacity, and financial efficiency.