The Income Statement

Transcription

1 The Income Statement An income statement is one of four financial statements that a producer needs to complete and analyze each year. The income statement (or profit and loss statement) is a summary of revenue received and business expenses incurred during a defined period, usually twelve months. Groups of income and expenses are called accounts. Accounts are simply descriptions indicating what type of income or expense is represented such as crop sales (income) or seed (expense). The income statement, once completed, provides the producer with a statement of profit (or loss) derived from the business. Why do you need an income statement? The income statement provides the producer with a measure of success of the business in terms of net income or loss for a particular period of time. Comparing income statements over time gives the producer an indication whether the business is profiting over time and moving towards the fulfillment of the business goals. Much of the information on the income statement, particularly the net income figure, can be used to calculate valuable financial ratios. These ratios can point out strengths and weaknesses quickly. Most lenders will want to see a previous years income statement to determine credit worthiness for a loan. How is it constructed? Income accounts are presented first on the income statement. Revenue can be from the sale of crops or livestock, agricultural program payments, custom work, dividends, etc. Expense accounts are presented below the income accounts. These could include labor, seed, fertilizer, etc. The income statement also includes expenses that are not paid in cash, such as depreciation. Once all income and expenses have been identified, the producer can determine true profitability by subtracting the total expenses for the production cycle from the total revenue. Net income for the farming business is the result which can be either positive or negative. Steps to constructing the income statement: 1. Transfer totals from Income Statement Transaction Log forms to the Income Statement Worksheet by enterprise/center. 2. Make sure any non-cash transactions are accounted for properly, especially depreciation. 3. Make year-end allocations so that all support and cost centers have transferred costs to a profit center. See the Allocations section of this curriculum. 4. Total each profit center and record results to the final income statement by enterprise. ** Note that the Total column on this final income statement represents to wholefarm income statement. Duckworth, Brenda, Stan Bevers, Rob Borchardt, and Blake Bennett. Department of Ag Economics, Texas Cooperative Extension, Texas A&M University. May 2003.

2 What are accrual adjustments, and how do they relate to the Income Statement? Accrual adjustments are necessary temporary adjustments made so that income and expenses presented are matched. In order to evaluate a specific enterprise, the production cycle must be complete (wheat is harvested, calves are weaned and ready for sale, vegetables are picked, etc.) and the income and expenses presented represent that particular enterprise. Income and expenses are matched to the represented production cycle and enterprise. An example of a necessary accrual adjustment is feed that has been fed to calves but has not been paid for. The amount owed, prorated for amount fed, should be included in current year expenses. When the feed debt is paid the following year, the accrual will be reversed by subtracting the accrued amount (previous year) from the cash transactions (following year). If the accrual is not reversed, the expense will be double-counted. Other examples of accrual adjustments are: Depreciation Income earned, but not yet received (deferred) Income received, but not earned Prepaid expenses Accounts payable/ accounts receivable Inventory Changes Management labor In short, if the input has been used it should be expensed, regardless of whether or not the payment has been made. If the income has been earned (resource given up) it should be included in the current year, regardless of whether or not the payment has been received. It should be pointed out that the IRS does not require accrual adjustments (or changes in inventory value) for tax purposes. In fact, the producer s tax accountant should be aware of any accrual adjustments because they should not be included for tax purposes if the producer pays taxes on a cash basis. However, until the manager produces an accrual- adjusted income statement, he does not know true profitability. How do producers figure accrual adjustments for prepaid expenses? Changes in prepaid inventory, like feed or supplies are the first indication of resources used. The basic formula for determining usage is: Beginning inventory + Purchases - Ending inventory Amount used L7.2

3 For example, a producer has $500 of feed in inventory at the beginning of the period and at the end of the period only has $300 of feed- his inventory has changed. He may have purchased feed during the year, but in effect, he utilized more than he purchased. From a tax standpoint, all purchases are included as feed expense, even though the producer fed some inventory he had on hand at the beginning of the year. Likewise, some of the feed actually purchased in the tax year may be held in inventory and used the following year. For tax purposes, the amount paid for in the tax year is expensed. From a management standpoint, the focus of bookkeeping is the measure the amount fed (used) in the given production cycle, even if the production cycle spans past the end of the taxable year. If the stocker calves are ready to sell in the spring, a producer should accumulate all costs associated with getting those calves all the way to the sale barn, including feed fed the previous year. This process matches the income produced with the actual expenses incurred; only then is true profitability measured. In the first year of accrual adjustments: The producer would simply estimate the amount of feed fed to the calves from the prior year, and make an accrual adjustment (add that amount to the feed expense.) The purchases (that have actually been paid for) should be recorded on the transaction logsubtract the amount remaining in ending inventory to arrive at the additional amount to be expensed. Be sure to keep a journal to show the tax accountant what adjustments have been made. In subsequent years of making accrual adjustments: Assume feed in inventory at the beginning of the year was fed first. The producer will not have a cash payment for this expense, so an adjustment should be made. To do this adjustment, the producer should reduce the previous year s ending inventory by the amount the inventory decreased, and record that amount to the income statement worksheet as a non-cash transaction. (Add expense to the income statement, subtract the same amount from the balance sheet.) For purchases, subtract ending inventory from total purchases (from the transactions log) and the remaining amount is added to the accrual (from previous year) to arrive at the total expense for the production cycle. Again, be sure to keep a journal to show the tax accountant what adjustments have been made. What about determining whether one enterprise is profitable? As discussed throughout this curriculum, most agricultural producers produce more than one commodity. Good management practices, such as evaluating each enterprise individually, are very important in today s agricultural industry. Good producers want to know which crop or livestock is making money and which is not. Unless producers know which crop or livestock is making money, they cannot eliminate the poor performing ones. L7.3

4 The first step in creating an income statement by enterprise is to keep cash transactions on the transaction log. The log is arranged by enterprise and specifies which report (income statement or balance sheet) the transaction should flow to. Note that all transactions recorded to this log reflect a cash transaction and will flow to the cash flow report. See sections on transaction log, cash flow report, and balance sheet for further explanations. An agricultural business should identify each enterprise of the business. What will I have to sell at the end of the production cycle? The production cycle may be different for each commodity and may span across years. For example, wheat is planted in the fall (in southern regions), but it is not harvested until early summer. Each enterprise, like corn, tomatoes, onions, wheat, weaned calves, stocker calves, etc., should be named as Profit Centers. For guidance on daily cash transactions, see the Transaction Log section of this curriculum. For non-cash transactions affecting the income statement, use the Income Statement Worksheet. What do I do with it once I have it? The income statement is a progress report of the business. The net income or loss for the farming or ranching business tells the operator whether or not the business is moving toward fulfilling the goals of the manager. By comparing the income statement over a number of years, profitability can be seen moving up or down. In addition, the manager will want to use the net income figure to calculate ratios to show the strengths and weaknesses of the business. Income statements by enterprise can help the producer determine which of his enterprises are contributing to the profits or which is taking profit away. Most importantly, the income statement is one tool in a toolbox of financial reports that helps a manager evaluate his business so that decisions are made based on a strong foundation of information. L7.4

5 Building the Income Statement Lesson Plan I. Goals A. Define an income statement. B. Teach methods of compiling the income statement. C. Explain uses of the income statement. II. Lesson Highlights and Descriptions A. What is an income statement? An income statement, also known as a Profit & Loss, is a report telling the story of Profit (result of operations), set within a specified timeframe (Jan-Dec). It tells the reader that from January to December how much money was earned and how much money was spent to earn it. Income statements also break the information down into accounts. Accounts are simply descriptions indicating what type of income or expense is represented. Keep in mind that all cash received is not necessarily income (sale of a tractor) and that all cash spent is not necessarily an expense (purchase of tractor.) As stated above, the income statement tells the story of how much Net Income a business makes from selling a product. Assets (equipment, buildings, breeding livestock) are inputs to producing a product, however, the input is not entirely used up within one production cycle. The inputs from these assets are added little by little to the products sold; the resulting expense is recorded in the form of depreciation (non-cash expense). Depreciation expense (percentage of purchase price) is recorded yearly to the income statement, but the purchase price of the asset at the time of purchase is recorded on the Balance Sheet in the fixed assets section. B. The transaction log design provides for even further income statement analysis. Agriculture producers typically produce multiple enterprises. Sometimes two crops are planted on the same acreage within the same year (double-cropping.) Profit margins (income less expenses) are extremely small in agriculture and can change dramatically from year to year. For this and many other reasons, a L7.5

6 high-yielding crop can actually be costing an operation more money than it is providing. It is a dog. Unless producers are aware of the enterprises that are making money and which are costing money, they cannot eliminate the bad ones. Likewise, if a particularly strong enterprise is not identified, a producer may not utilize it fully. The transaction log design provides for analysis of enterprises individually, including overhead costs. Income Statements by Enterprise are an integral component of a successful accounting system. C. Income Statements by Enterprise are compiled by recording totals from the Transaction Log to the income statement worksheets by enterprise. Non-cash transactions per enterprise can be recorded directly to the income statement worksheets. The worksheets allow spaces for both cash and non-cash transactions. An example of a noncash transaction would be depreciation, management labor, or bartering. There are spaces on the transaction log for both management labor and depreciation; however, these amounts are recorded in the Labor Support Center and Machinery & Equipment Support Center, respectively. At the end of the year, they are allocated back to the responsible enterprises. Products sold absorb all costs. D. Once all cash and non-cash transactions are recorded on the worksheets, those totals (again, by enterprise) are taken to the final Income Statement by Enterprise. E. Income statements provide one more piece of the financial puzzle of a business. As mentioned above, they are important in planning. An income statement is one of the most demanded reports of all financial statements. Tax information is determined from income statements, lenders make decisions, in part, from income statements, and it is the one report in which producers are most interested. III. Potential Speakers A. Extension Agents B. Extension Specialists L7.6

7 IV. Review Questions A. The income statement reflects a running balance of items owned or owed as of a certain date. (True or False) False. The income statement tells about the net income resulting from operations within a specified range of time. The balance sheet tells about what a business owns vs. what is owes (% ownership) as of a certain date (running balance.) B. Should the income statement reflect all cash purchases during the year? No. The expense portion of the income statement should reflect the inputs actually used in producing the income reflected. The unused portion of inputs purchased (extra fertilizer, feed, etc.) should be held in inventory on the balance sheet. Likewise, purchases of assets, like machinery, should not be included as an expense; rather, the purchase amount should increase the balance of the non-current asset section of the balance sheet and the related current depreciation should be included as an expense for the year. C. Note payments are considered an expense. (True or False) False. The principle portion of the payment reduces the balance of the corresponding liability (debt) on the balance sheet, and the interest portion only is included on the income statement as an expense. L7.7

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9 Income Statement Overheads Introduction The income statement (profit & loss) tells the reader the result of operations, or net income from operations within a specified range of time. Income Statements by Enterprise break the income and expenses down by responsible enterprise so that each commodity can be individually evaluated. The profit centers must eventually absorb, on a pro rata basis, all costs of the business, including management labor, depreciation, taxes, utilities, labor, etc. Internally used income statements include both cash and noncash transactions. Tax-based income statements include only cash transactions (if the producer reports on a cash basis.) The tax accountant would be most interested in the Transaction Log so that he/she can readily determine the cash transactions. Steps to compiling an income statement: 1. Transfer cash totals by account from the transaction log to the income statement worksheets. * Non-cash transactions, like depreciation expense, should be recorded directly to the income statement worksheets. 2. Allocate support centers to responsible profit centers, and record the allocations as a non-cash transaction on the income statement worksheets. (The support centers should now have a zero balance.) 3. Transfer center totals by account, including profit and support centers, to the final Income Statement by Enterprise report. L7.9

10 Income Statement Case Application The Doe s income statement is shown below. The income statement details the income and expenses associated with the farming business, including the family living withdrawals (personal), depreciation (a real business expense), and interest costs associated with the land purchase. It does not include Mrs. Doe s salary As shown, the farming operation generated $18,569 in revenue. This includes revenue from the sale of calves, cull cows and vegetables. Total cash expenses for the operation were $30,250. However, depreciation added $3,629 to this figure. Total cash and non-cash expenses were $33,879. Major expense items include personal withdrawals, hired labor (the son s wages), depreciation, and feed for the cattle. These four expenses account for 75% of the operations total expenses. Given these incomes and expenses, the net farm income from operations was a loss of $15,310. The operation needs to either increase the income generated, reduce expenses, or allocate some of the personal expenses away from the farming business. L7.10