Think about how your farm has grown in size and scope over the past decade. Has your financial reporting followed suit?
“Farmers really struggle with anticipating the needs for better financial reporting,” says Curt Covington, senior director of institution credit at AgAmerica Lending. “One of the biggest risks farmers make as they grow is information risk.”
Covington defines information risk as the quality of the financial data and information farmers are collecting, analyzing and acting on. To have the best information today, he says farmers must adopt accrual accounting.
Most farmers use cash basis accounting, says Paul Neiffer, CPA and principal with CLA.
The main difference between accrual basis and cash basis accounting is the time at which income and expenses are recognized and recorded. The cash basis method generally recognizes income when cash is received and expenses when cash is paid. The accrual method recognizes income when it is earned and expenses when they are incurred.
"It's important for farmers to understand that cash accounting — cash in, cash out — does not do a very good job of explaining what your farm really made," he says. “It doesn't help you plan forward. By using farm accrual accounting on an on-going basis (not simply making some adjustments at year-end), you can accurately determine how much income you generated off of this year’s crops and know what you really made for the year, not what you show to the tax man.”
Listen to Covington on The Farm CPA Podcast with Paul Neiffer:
For today’s complex farm operations, accrual accounting can remove some of the guesswork and provide better information for multiyear projections, Covington says. It can also make your loan renewal process easier.
“You want to get your loans approved quicker? You want to get it done with less questions? Provide us accrual based financial reporting,” he says.
The switch to more comprehensive financial reporting, Covington admits, can be a bit tedious. “Plus, farmers often say they don’t see the benefit to the cost,” he says.
Yet he encourages farmers to look at adding someone to the team who can provide strong bookkeeping and/or analytical skills.
“Once you employ managerial accounting principles to understand the enterprises in your business, you’ll see the benefits,” he says. “It is one of the most valuable tools you can implement.”
Assess Your Farm Financial Reporting
Successful and profitable farmers display certain financial habits that separate them from others. These habits, consistently applied through the years, add up, and the results are evident. Paul Neiffer, CPA and principal with CLA, encourages farmers to ask themselves these questions:
Are you using a computerized accounting system?
Do you record your income and expenses on some type of accrual system?
Do you print out your balance sheet, income statement and statement of cash flows on a monthly basis and use it in your farm operation?
Do you know more about your farm finances than your banker does?
Do you book crop inventories on your balance sheet?
Do you calculate your deferred tax liability and know what that means?
Do you calculate depreciation based on some type of economic depreciation or book depreciation?
Do you prepare both historical and fair market value balance sheets?
If you do at least six out of eight, give yourself an A. If you do four to five, give yourself a B-. Less than four is likely a failing grade on your farm financial reporting.
“For those farmers with a failing grade, I would suggest looking at the guidelines at the Farm Financial Standards Council website,” Neiffer says. “They can help you get a passing grade.”
May 4, 2022