4 pp.Those who succeed will manage their operations as farm/ranch businesses, with more emphasis on recordkeeping, planning, profitability analysis and repayment-based financing, and with better production and business monitoring and controls. This publication explains ways to manage the farm/ranch business

Klinefelter, Danny A.

Pena, Jose G.

Texas A&M University

1Financial Management:  
The Key to Farm-Firm Business Management
Risk Management
E-491
RM5-10.0 
10-08
*Professors and Extension Economists–Management, The Texas A&M System.
Most farmers and ranchers still prefer to 
concentrate on production rather than planning, 
recordkeeping and marketing. However, the es-
calation in input costs, the ability to access capi-
tal, and greater volatility in commodity markets 
make financial and risk management skills very 
important. Reductions in the government farm 
program safety net, advances in biotechnology 
and information technology, and the increasing 
globalization of competition will continue to 
strain traditional approaches to management as 
we move further into the 21st Century. 
Those who succeed will manage their opera-
tions as farm/ranch businesses, with more em-
phasis on recordkeeping, planning, profitability 
analysis, and repayment-based financing, and 
with better monitoring of production and busi-
ness processes. While production can not be 
neglected, it should be balanced with attention 
to other key performance areas. 
The purchase of inputs should be based on 
economic analysis, not just increased output. 
Successful producers will need more informa-
tion about financial analysis, marketing, analy-
sis of alternative enterprises, and the “bottom 
line” contribution of each existing enterprise. 
This shift applies equally to lending institu-
tions. Lenders will have to undertake more 
in-depth financial and risk analysis. “Equity/
collateral” and “character” lending protect the 
lender, but if the producer can not generate 
sufficient profits and cash flow to service debt, 
the lender is doing a disservice to the producer 
by providing capital that may end up actually 
increasing risk and jeopardizing the producer’s 
operation and equity. 
As a result, agricultural producers and their 
lenders must adopt some of the basic analyti-
cal and planning tools used in business. To 
start with, a producer should ask and honestly 
answer the following  questions: 
Is this an efficient production system? • 
Can commodities be produced below the • 
average cost of production? 
Is there a marketing plan based on • 
adequate market analysis and the break-
even price for each commodity being 
produced? 
Is there an accurately prepared business • 
plan based on economic considerations? 
Does the business have sufficient equity • 
and liquidity to handle adversity or a 
cyclical downturn?
Is the operation large enough to provide • 
the required family living withdrawal?  
If not, is there sufficient off-farm income? 
Have the risks involved in the business • 
been adequately analyzed and 
compensated for? 
Jose G. Pena and Danny Klinefelter*
2Is there an adequate system for obtaining • 
management information and monitoring 
business performance? 
Questions like these should be addressed 
continually, and not just during an initial plan-
ning process. 
Developing Financial 
Management Skills 
Answering these questions will require a 
thorough analysis of the operation and may 
require financial and marketing management 
skills the producer does not yet possess or prac-
tice. Many producers will need to embark upon 
an intensive educational program to gain the es-
sential farm/ranch business management skills 
and the confidence to use them successfully. 
Producers who want to succeed need to de-
velop a farm/ranch business plan that outlines, 
in detail, how they plan to generate a profit and 
manage business risks. They should start by 
outlining specific business/personal goals and 
objectives and preparing complete inventories of 
resources available. That is, they can not pre-
pare a meaningful plan unless they specifically 
outline what they wish to accomplish and the 
basic “resources” available to accomplish this 
“objective.” 
The resource inventory should cover all areas 
of the business and include such items as farm/
ranch maps by productive capacity, soil analysis, 
water resources, machinery, labor skills avail-
able, management capabilities, detailed crop/
livestock production history, analysis of market 
information, and complete financial statements. 
The Planning Process 
With the data obtained in the first step of the 
planning process, a producer can begin develop-
ing and comparing alternative production, mar-
keting and financing plans. The goals indicate 
business and personal priorities and help estab-
lish performance objectives. Data on the physical 
resources (including the land, labor, tangible 
working assets, and capital), the institutional 
considerations, and the managerial capacity 
(strengths and weaknesses) suggest the range of 
enterprises, production systems, and marketing 
tools to consider in preparing a comprehensive 
whole farm/ranch plan. 
The next task is to develop a plan the operator 
will follow for several years. A long-term plan 
integrates the production, management, market-
ing and financing activities that will be required 
to accomplish the operator’s goals. This plan may 
require a significant change in the current busi-
ness structure. At a minimum, the plan should 
include: 
A complete resource inventory and a • 
specific outline of goals and objectives.
A 5-year crop/livestock rotation plan. • 
Enough years should be included in the 
plan to move through any transition in 
production and financing that may cause 
significant fluctuations in the year-to-year 
cash flows. 
Capital improvements needed • 
immediately (first planning year), in the 
intermediate term (1 to 5 years), and long 
term (5 to 10 years). 
Capital needed for operating the business • 
and for the long term.  
A physical production plan by commodity • 
and for the whole farm/ranch. A calendar 
of events by month and by year, outlining 
all of the required production practices 
and resources, should be prepared for 
each commodity and for the whole farm/
ranch. 
A long-term strategic assessment based • 
on both historical data and current 
outlook information. This should include 
an assessment of government farm 
programs, the general economic outlook 
(e.g., inflation, interest rates, taxes), 
specific industry/commodity outlook 
(trends and cycles), and technological 
developments.  
Individual enterprise budgets and a • 
consolidated whole farm/ranch cash flow 
projection by month for at least the first 
year, and by year for the following years. 
3A marketing plan for the contemplated • 
enterprises. The marketing plan should 
include sensitivity analysis for at least 
three price levels: expected, pessimistic 
and optimistic. 
Although the items mentioned above are 
listed separately, they are actually part of an 
integrated planning process. For example, the 
resource inventory should help to identify po-
tential farm/ranch enterprises. A budget forecast 
for current and potential enterprises, using the 
three alternative price scenarios, should identify 
alternatives with the greatest potential profit-
ability and those whose profitability is most 
uncertain. Scarce resources such as capital, land 
and labor should be allocated to the most profit-
able enterprises. A 5-year crop/livestock rotation 
plan would increase the probability of sustain-
ing maximum economic yields. By combining 
operating and long-term capital requirements 
into a multi-year cash flow projection, a pro-
ducer can better evaluate the financial feasibil-
ity of short-, intermediate- and long-term plans. 
Balance sheets and projected income statements 
will be needed to evaluate net worth, profitabil-
ity, economic efficiency and financial structure. 
If not being done already, detailed enterprise 
and whole farm/ranch records should be kept 
from the time the plan is implemented. Financial 
statements and cash flow projections with “what 
if” analysis should be prepared and adjusted as 
often as necessary to analyze risks and keep the 
plan on track. Successful business management 
requires continuous monitoring and control. 
Financial Statements
A farm/ranch recordkeeping system facilitates 
the preparation of financial statements and the 
monitoring of business performance. Properly 
prepared balance sheets, income statements and 
cash flow projections will be needed to help the 
manager keep the business on track. This is done 
by comparing actual performance to the plan 
and taking action when necessary. Farm busi-
nesses have failed simply because the farmer or 
his lender recognized problems and took correc-
tive action too late. 
Financial Analysis of a Farm  
or Ranch Operation 
High among any business’s goals should be 
profitability, liquidity, solvency and efficiency. 
Yet, some managers who are very capable in the 
technical and production aspects of their busi-
nesses are completely in the dark when it comes 
to measures of business status and performance. 
They leave their recordkeeping to bookkeepers, 
or worse, use the “shoebox” record system. The 
only “business analysis” they do is to sign their 
tax forms or prepare “required” financial infor-
mation for their lenders.  
Effective managers are able to determine the 
financial position and performance of the busi-
ness at any time. They can evaluate where the 
business is, has been, and is going, which helps 
them control the business operation over time. 
They can develop sound operating plans and ar-
range for credit needs. 
The basic tools needed to conduct farm/ranch 
business analysis are adequate records and 
properly prepared, complete financial state-
ments. 
Farm and Ranch Financial 
Statements 
The most useful coordinated financial state-
ments to use for summarizing a farm’s or ranch’s 
financial position, and for demonstrating mana-
gerial ability, are the balance sheet, income state-
ment and cash flow statement. These financial 
statements allow a producer to systematically 
analyze financial progress, plan operations for 
the year ahead, and demonstrate creditworthi-
ness to lenders. To be most useful, these state-
ments should be compared over several years. 
If not available from previous years, there is no 
better time to start preparing these statements 
than now. 
4The Balance Sheet 
The balance sheet, also referred to as the 
statement of financial position or net worth state-
ment, is a summary of all assets and liabilities of 
the farming or ranching operation at a specific 
point in time. At a minimum, a balance sheet 
should be prepared as of the last day of the fiscal 
year. 
The Income Statement 
The income statement reflects the profitability 
of a farm/ranch business over a period of time, 
usually from the beginning to the end of the 
tax year. For accurate analysis, it is critical that 
income be calculated on an accrual-adjusted 
basis. This does not imply, however, that farm-
ers/ranchers should not use the more flexible 
cash basis for tax accounting. It does mean that 
cash basis income accounting for management 
purposes can give a very distorted and inac-
curate picture of business performance, and 
can produce lags of up to 2 years in recognizing 
profitability problems that may be developing. 
The Cash Flow Statement 
A projected cash flow statement is a listing of 
all anticipated cash inflows and outflows for a 
specified future period. It includes both farm/
ranch and non-farm income, and all projected 
cash outflows, including operating expenses and 
capital outlays, family living expenses, borrow-
ing transactions and tax payments. 
Using and Analyzing  
Financial Statements 
Farmers and ranchers should use the infor-
mation provided by the balance sheet, income 
statement and cash flow statement to measure 
and understand business performance. Only by 
analyzing the components of all three financial 
statements and their interrelationships can a 
clear picture of financial position and perfor-
mance be developed. 
There are three warnings that reinforce the 
importance of using all three statements. 
The first is that a business can be going • 
broke and still be generating a positive 
cash flow for a period of time by deferring 
expenses, restructuring or refinancing 
debts, selling off assets (including 
inventories), and not replacing capital 
assets as they wear out (i.e., living off of 
depreciation).
Second, unless 1) the operator is • 
generating enough off-farm income, 2) 
assets are appreciating faster than the 
business is losing money, and/or 3) the 
operator is inheriting sufficient money 
(assets) to offset losses, a business has to 
be profitable to survive in the long run.
Third, many farmers and ranchers have • 
failed even though the business was 
profitable because they were consuming 
more than the business was earning. 
After a careful review of all factors involved, 
the farmer/rancher may decide that something 
needs to be done. Unfortunately, there is no 
single prescription that will work for every 
operation. Like a medical problem, the solution 
will depend on a specific diagnosis based on the 
business and the individuals involved. Finan-
cial statements that are carefully prepared and 
analyzed will help the manager see warning 
signs in time to make needed adjustments. Good 
financial analysis does not guarantee success, 
but it definitely improves the odds.
Educational programs of the Texas AgriLife Extension Service are open to all people without regard to race, color, sex, 
disability, religion, age, or national origin.
Issued in furtherance of Cooperative Extension Work in Agriculture and Home Economics, Acts of Congress of May 
8, 1914, as amended, and June 30, 1914, in cooperation with the United States Department of Agriculture. Edward G. 
Smith, Director, Texas AgriLife Extension Service, The Texas A&M System.
Produced by AgriLife Communications, The Texas A&M System
Extension publications can be found on the Web at: http://AgriLifeBookstore.org.
Visit Texas AgriLife Extension Service at http://AgriLifeExtension.tamu.edu.
Partial funding support has been provided by the
Texas Corn Producers, Texas Farm Bureau, and
Cotton Inc.–Texas State Support Committee. 


English

Financial Management: The Key to Farm-Firm Business Management

Texas A&amp;M Repository

1Financial Management:  The Key to Farm-Firm Business ManagementRisk ManagementE-491RM5-10.0 10-08*Professors and Extension Economists–Management, The Texas A&M System.Most farmers and ranchers still prefer to concentrate on production rather than planning, recordkeeping and marketing. However, the es-calation in input costs, the ability to access capi-tal, and greater volatility in commodity markets make financial and risk management skills very important. Reductions in the government farm program safety net, advances in biotechnology and information technology, and the increasing globalization of competition will continue to strain traditional approaches to management as we move further into the 21st Century. Those who succeed will manage their opera-tions as farm/ranch businesses, with more em-phasis on recordkeeping, planning, profitability analysis, and repayment-based financing, and with better monitoring of production and busi-ness processes. While production can not be neglected, it should be balanced with attention to other key performance areas. The purchase of inputs should be based on economic analysis, not just increased output. Successful producers will need more informa-tion about financial analysis, marketing, analy-sis of alternative enterprises, and the “bottom line” contribution of each existing enterprise. This shift applies equally to lending institu-tions. Lenders will have to undertake more in-depth financial and risk analysis. “Equity/collateral” and “character” lending protect the lender, but if the producer can not generate sufficient profits and cash flow to service debt, the lender is doing a disservice to the producer by providing capital that may end up actually increasing risk and jeopardizing the producer’s operation and equity. As a result, agricultural producers and their lenders must adopt some of the basic analyti-cal and planning tools used in business. To start with, a producer should ask and honestly answer the following  questions: Is this an efficient production system? • Can commodities be produced below the • average cost of production? Is there a marketing plan based on • adequate market analysis and the break-even price for each commodity being produced? Is there an accurately prepared business • plan based on economic considerations? Does the business have sufficient equity • and liquidity to handle adversity or a cyclical downturn?Is the operation large enough to provide • the required family living withdrawal?  If not, is there sufficient off-farm income? Have the risks involved in the business • been adequately analyzed and compensated for? Jose G. Pena and Danny Klinefelter*2Is there an adequate system for obtaining • management information and monitoring business performance? Questions like these should be addressed continually, and not just during an initial plan-ning process. Developing Financial Management Skills Answering these questions will require a thorough analysis of the operation and may require financial and marketing management skills the producer does not yet possess or prac-tice. Many producers will need to embark upon an intensive educational program to gain the es-sential farm/ranch business management skills and the confidence to use them successfully. Producers who want to succeed need to de-velop a farm/ranch business plan that outlines, in detail, how they plan to generate a profit and manage business risks. They should start by outlining specific business/personal goals and objectives and preparing complete inventories of resources available. That is, they can not pre-pare a meaningful plan unless they specifically outline what they wish to accomplish and the basic “resources” available to accomplish this “objective.” The resource inventory should cover all areas of the business and include such items as farm/ranch maps by productive capacity, soil analysis, water resources, machinery, labor skills avail-able, management capabilities, detailed crop/livestock production history, analysis of market information, and complete financial statements. The Planning Process With the data obtained in the first step of the planning process, a producer can begin develop-ing and comparing alternative production, mar-keting and financing plans. The goals indicate business and personal priorities and help estab-lish performance objectives. Data on the physical resources (including the land, labor, tangible working assets, and capital), the institutional considerations, and the managerial capacity (strengths and weaknesses) suggest the range of enterprises, production systems, and marketing tools to consider in preparing a comprehensive whole farm/ranch plan. The next task is to develop a plan the operator will follow for several years. A long-term plan integrates the production, management, market-ing and financing activities that will be required to accomplish the operator’s goals. This plan may require a significant change in the current busi-ness structure. At a minimum, the plan should include: A complete resource inventory and a • specific outline of goals and objectives.A 5-year crop/livestock rotation plan. • Enough years should be included in the plan to move through any transition in production and financing that may cause significant fluctuations in the year-to-year cash flows. Capital improvements needed • immediately (first planning year), in the intermediate term (1 to 5 years), and long term (5 to 10 years). Capital needed for operating the business • and for the long term.  A physical production plan by commodity • and for the whole farm/ranch. A calendar of events by month and by year, outlining all of the required production practices and resources, should be prepared for each commodity and for the whole farm/ranch. A long-term strategic assessment based • on both historical data and current outlook information. This should include an assessment of government farm programs, the general economic outlook (e.g., inflation, interest rates, taxes), specific industry/commodity outlook (trends and cycles), and technological developments.  Individual enterprise budgets and a • consolidated whole farm/ranch cash flow projection by month for at least the first year, and by year for the following years. 3A marketing plan for the contemplated • enterprises. The marketing plan should include sensitivity analysis for at least three price levels: expected, pessimistic and optimistic. Although the items mentioned above are listed separately, they are actually part of an integrated planning process. For example, the resource inventory should help to identify po-tential farm/ranch enterprises. A budget forecast for current and potential enterprises, using the three alternative price scenarios, should identify alternatives with the greatest potential profit-ability and those whose profitability is most uncertain. Scarce resources such as capital, land and labor should be allocated to the most profit-able enterprises. A 5-year crop/livestock rotation plan would increase the probability of sustain-ing maximum economic yields. By combining operating and long-term capital requirements into a multi-year cash flow projection, a pro-ducer can better evaluate the financial feasibil-ity of short-, intermediate- and long-term plans. Balance sheets and projected income statements will be needed to evaluate net worth, profitabil-ity, economic efficiency and financial structure. If not being done already, detailed enterprise and whole farm/ranch records should be kept from the time the plan is implemented. Financial statements and cash flow projections with “what if” analysis should be prepared and adjusted as often as necessary to analyze risks and keep the plan on track. Successful business management requires continuous monitoring and control. Financial StatementsA farm/ranch recordkeeping system facilitates the preparation of financial statements and the monitoring of business performance. Properly prepared balance sheets, income statements and cash flow projections will be needed to help the manager keep the business on track. This is done by comparing actual performance to the plan and taking action when necessary. Farm busi-nesses have failed simply because the farmer or his lender recognized problems and took correc-tive action too late. Financial Analysis of a Farm  or Ranch Operation High among any business’s goals should be profitability, liquidity, solvency and efficiency. Yet, some managers who are very capable in the technical and production aspects of their busi-nesses are completely in the dark when it comes to measures of business status and performance. They leave their recordkeeping to bookkeepers, or worse, use the “shoebox” record system. The only “business analysis” they do is to sign their tax forms or prepare “required” financial infor-mation for their lenders.  Effective managers are able to determine the financial position and performance of the busi-ness at any time. They can evaluate where the business is, has been, and is going, which helps them control the business operation over time. They can develop sound operating plans and ar-range for credit needs. The basic tools needed to conduct farm/ranch business analysis are adequate records and properly prepared, complete financial state-ments. Farm and Ranch Financial Statements The most useful coordinated financial state-ments to use for summarizing a farm’s or ranch’s financial position, and for demonstrating mana-gerial ability, are the balance sheet, income state-ment and cash flow statement. These financial statements allow a producer to systematically analyze financial progress, plan operations for the year ahead, and demonstrate creditworthi-ness to lenders. To be most useful, these state-ments should be compared over several years. If not available from previous years, there is no better time to start preparing these statements than now. 4The Balance Sheet The balance sheet, also referred to as the statement of financial position or net worth state-ment, is a summary of all assets and liabilities of the farming or ranching operation at a specific point in time. At a minimum, a balance sheet should be prepared as of the last day of the fiscal year. The Income Statement The income statement reflects the profitability of a farm/ranch business over a period of time, usually from the beginning to the end of the tax year. For accurate analysis, it is critical that income be calculated on an accrual-adjusted basis. This does not imply, however, that farm-ers/ranchers should not use the more flexible cash basis for tax accounting. It does mean that cash basis income accounting for management purposes can give a very distorted and inac-curate picture of business performance, and can produce lags of up to 2 years in recognizing profitability problems that may be developing. The Cash Flow Statement A projected cash flow statement is a listing of all anticipated cash inflows and outflows for a specified future period. It includes both farm/ranch and non-farm income, and all projected cash outflows, including operating expenses and capital outlays, family living expenses, borrow-ing transactions and tax payments. Using and Analyzing  Financial Statements Farmers and ranchers should use the infor-mation provided by the balance sheet, income statement and cash flow statement to measure and understand business performance. Only by analyzing the components of all three financial statements and their interrelationships can a clear picture of financial position and perfor-mance be developed. There are three warnings that reinforce the importance of using all three statements. The first is that a business can be going • broke and still be generating a positive cash flow for a period of time by deferring expenses, restructuring or refinancing debts, selling off assets (including inventories), and not replacing capital assets as they wear out (i.e., living off of depreciation).Second, unless 1) the operator is • generating enough off-farm income, 2) assets are appreciating faster than the business is losing money, and/or 3) the operator is inheriting sufficient money (assets) to offset losses, a business has to be profitable to survive in the long run.Third, many farmers and ranchers have • failed even though the business was profitable because they were consuming more than the business was earning. After a careful review of all factors involved, the farmer/rancher may decide that something needs to be done. Unfortunately, there is no single prescription that will work for every operation. Like a medical problem, the solution will depend on a specific diagnosis based on the business and the individuals involved. Finan-cial statements that are carefully prepared and analyzed will help the manager see warning signs in time to make needed adjustments. Good financial analysis does not guarantee success, but it definitely improves the odds.Educational programs of the Texas AgriLife Extension Service are open to all people without regard to race, color, sex, disability, religion, age, or national origin.Issued in furtherance of Cooperative Extension Work in Agriculture and Home Economics, Acts of Congress of May 8, 1914, as amended, and June 30, 1914, in cooperation with the United States Department of Agriculture. Edward G. Smith, Director, Texas AgriLife Extension Service, The Texas A&M System.Produced by AgriLife Communications, The Texas A&M SystemExtension publications can be found on the Web at: http://AgriLifeBookstore.org.Visit Texas AgriLife Extension Service at http://AgriLifeExtension.tamu.edu.Partial funding support has been provided by theTexas Corn Producers, Texas Farm Bureau, andCotton Inc.–Texas State Support Committee. 

http://oaktrust.library.tamu.edu/bitstream/handle/1969.1/87858/pdf_984.pdf?sequence=1&isAllowed=y

Financial Management: The Key to Farm-Firm Business Management

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Texas A&M University

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Financial Management: The Key to Farm-Firm Business Management

Abstract

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Full text

Available Versions

Texas A&M University

Texas A&amp;M Repository

Texas A&M Repository