|The Business of Farming|
|Why Keep Farm Financial Records?|
Many times, producers only keep records for tax purposes and by doing so they do a great injustice to themselves. Although tax reporting is legally required, when farm financial records are correctly kept, they also can be used to acquire loans, assess financial and performance condition, and aid in decision making. Good management is critical in the success and longevity of any operation. Recordkeeping allows one to measure and report the effectiveness of management decisions so operators can make sound decisions. Farm records serve the following purposes:
Reporting and Preparing Tax Returns. Typically, a less sophisticated record system is needed (when compared to financial and management accounting system) to report income and expense to the IRS. However, one never knows when their operation may be subject to an audit by the IRS, thus care should be taken in developing and implementing a recordkeeping system. If an operation is audited, it will need to provide documentation for all income and expense.
Obtaining Financing for the Operation. Lending organizations require detailed information about the farming operation before providing a loan. Although good records do not guarantee one will obtain financing for their farming operation — no or poor records will almost certainly ensure a denied loan application. Records not only provide the lender with needed information, good records demonstrate your management ability.
Assess Financial Condition. If a farm operator is truly interested in sustaining and growing their business, they will make informed decisions. To obtain relevant information to make sound decisions, good records must be kept to allow the development of financial statements. Once these statements have been prepared, the farm’s operations can be analyzed to allow the operator to assess its financial condition. Good financial records provide: 1) condition and health of the operation and enterprises; 2) profitability during defined periods; 3) prediction of future needs; and 4) determine the best use of resources for future use.
Financial statements summarize the financial status of the operation. The two main financial statements are the balance sheet and income statement. The balance sheet shows what an operation owns, what it owes and what investments the owners have in the operation. It is a snapshot of the operation, at a specific point in time, showing its financial condition. The income statement is a summary of the farm’s operations over a certain period of time. It illustrates the current financial position of the operation as well as demonstrates the changes since the last time the balance sheet was prepared.
Once financial statements are prepared, the operation’s performance can then be evaluated by using financial ratios analyzing the operation’s profitability, liquidity, solvency and efficiency. Since each operation is unique, the management of the operation should develop benchmarks to aid in determining the financial condition and performance.
Succession and Estate Planning. When the time comes for the farm’s operations to be managed by the next generation, good records are invaluable. If the retiring owner-operator requires the new operator to "buy out" the operation, the new operator will most likely need to obtain financing. A lending agency will require past financial history of the operation to determine if it is feasible for the next generation to continue.
If no one in the family is interested in continuing the operation, deciding how the business and assets will be handled when the business is no longer operating can reduce much headache and heartache.
In estate planning, it is heard many times, "I’ll let the kids deal with it after I die." If one truly wants their family to continue in a meaningful relationship and desires the legacy of their operation to continue, they should make the hard decisions now about estate and succession planning rather than leaving it to chance.
At the end of the day, it doesn’t matter how many acres you farm, the size of your cattle operations or if you have the latest and best equipment. If you intend to be a successful, long-term operation, the farm must generate income. Good farm financial records are vital in measuring profitability, aiding in tax reporting, acquiring financing, monitoring the health of the operation and transitioning the farm to the next generation. Recordkeeping is not fun or glamorous, but it is a vital part of your operation.
Note: The items covered in this article are informational only and are not meant as tax, legal or financial advice; consult with your tax professional, lawyer or financial consultant for guidance on issues specific to your situation. The author does not endorse any websites, companies or applications, and cannot attest to the accuracy of the information provided by third-party sites or any other linked site.
The author is an Extension Economist with the Alabama Cooperative Extension System. For more information about farm management and financial analysis, please contact your County Extension Coordinator or an Extension Specialist: North Alabama: Holt Hardin, (256) 574-2143 or Robert Page, (256) 528-7133; Central Alabama: Jamie Yeager, (334) 624-4016; Southwest Alabama: Steve Brown, (251) 867-7760; Southeast Alabama: Thomas Hall, (334) 693-2010.