Does farm business accounting matter?
What is one of the most important jobs on the farm that is also the most neglected job? Without a doubt, it is the farm business accounting portion of the operation. Many operations view this task as a necessary evil, making it a job that may only be completed once a year before the meeting with the bank or before it is time to file a tax return.
Most operators would agree that managing the farm’s finances is one of the most important jobs on the farm despite the neglect it receives. There are hundreds of thousands, if not millions, of dollars, flowing through the farm’s account each year. Yet there is a simple question that goes unanswered: “Did the operation make money last year?” This cannot be determined by simply looking at the balance in the checkbook.
Most farms keep their accounting on the cash basis of accounting because that is how the Schedule F on the tax return is reported. This means that income is recorded when there are deposits and expenses are recorded when there are checks written. If deposits are greater than checks written, an operation made money that year, right? Not necessarily.
Let’s look at how deposits and checks flow through in a crop year. Often, the farm is collecting income and writing checks that cover three crop cycles. For example, in 2021, operations will have likely sold 2020 and/or 2021 crop; paid for 2021 overhead expenses such as insurance, repairs and utilities; and will pay for 2022 crop inputs such as seed, chemical and fertilizer.
Couple this with the fact that an operation’s revenue fluctuates daily with changes in grain and livestock prices – accounting on the farm is more complex than it gets credit for. In fact, it is more complicated than most small businesses due to constant fluctuations of input costs, output value and the inconsistent flow of those expenses and revenues. So, what’s the answer?
Accrual accounting is the answer to this problem. To describe it simply, accrual accounting is the way an operation thinks about the farm’s year. If an operation completed harvest after harvesting a record crop with a profitable price, they would say it was the best year on record. At the end of the year though, why don’t the financial statements reflect that success? That begs the question, what good is an accounting system if it cannot answer the simple question – “Did we make money this year?”
Moving to an accrual basis is the first step for an operation to allow its accounting system to start paying dividends for the farm.
Accrual accounting transforms your accounting system from a purely compliance tracking system to a managerial tool that increases visibility that allows an operation to make more informed decisions to drive profitability. It answers these simple yet complex questions of:
- “Are we profitable?”
- “Which crops are making us money?”
- “Are we in a good working capital position?”
- “Are we cash-flowing enough to cover our debt payments?”
- “Should we take on that ground at that price?”
Given the dollars and risk that is at stake in farming, these are important questions to know the answers to.
Getting your accounting system moved from cash to accrual accounting can be a tough task for those unfamiliar with the structure and process. Working with a trusted agribusiness advisor that not only understands accounting but also understands the business of farming is critical to your success. An agribusiness advisor can be much more than just someone to manage your taxes, they can understand everything you go through as a farmer. They can be a key business partner to help provide you with accurate financial information that drives decision making in your operation.
Farm sustainability is what this boils down to. It is a desire of farmers to pass the farm down to the next generation and to leave the land in better shape.
There is a missing piece to that equation for this to happen – financial stability. What would happen if an operation placed as much emphasis on passing on a better financial position to the next generation? Doing so will enhance the chances that there is a viable and profitable operation there for the next generation. That is what leaving a legacy is all about.
Adam Bormann, CPA, is an agribusiness professional with ELO CPAs & Advisors, a leading southeastern South Dakota accounting and consulting firm with offices in Sioux Falls, Mitchell, Yankton, Huron, Chamberlain and Miller.