Why you need financial statements to successfully manage your business ...

... and how Farm Credit can help!

The importance of keeping adequate business records cannot be overemphasized. Without accurate and up-to-date financial records, you cannot determine how well your business is doing or where it is going. At a minimum, you need records to substantiate your tax obligations and secure credit.

But if the only reasons you keep financial records are to make Uncle Sam and your creditors happy, then it's time to reevaluate. The most important reason to maintain good records is, quite simply, to manage your business successfully and to increase profits.

Good records can move you closer to achieving your business goals. Think of your records as road maps to help you get where you want to go. Perhaps you want to start a new enterprise or send your children to college. Maybe your goal is to expand and bring the next generation into the business. Or you might want to create a secure retirement.

Whatever your goals are, it will be much easier to achieve them by connecting them to your financial records. The type of records depends on your particular operation. Your Farm Credit loan officer or record-keeping specialist can help you determine the set of financial records that will work best for your business.

Two basic items

As a business manager, you need to understand two basic financial statements:

• A balance sheet is a statement of your business's financial position at a specific point in time. Your balance sheet is a yardstick by which you can measure year-to-year progress, and analyze how you've done over a particular time period.
• An income (or profit and loss) statement lists the funds that go into your business and those that go out. It is a summary of your receipts, expenses and net profit (or loss) over a given period of time (for example, year to date or current month). In short, it tells you exactly how much money you make and how much you spend.

Mike Farmer, a loan officer with the St. Albans, Vt. office of Yankee Farm Credit, says, "Some business owners tell us they don't need a balance sheet or income statement because they run their business from their checkbooks. These folks interpret money in their checking accounts as profit - even if that 'profit' includes borrowed money! But any loan officer will tell you that successful business owners rely on financial statements for business planning."

Jeff Barron, a loan officer for Farm Credit of Maine, agrees. "In many industries, thin operating margins and high input expenses can squeeze profit margins, so familiarity with financial numbers is essential to long-term profitability."

Jeff knows many ag business owners who aren't comfortable creating or reading statements. He urges those folks to become more knowledgeable. "Take a course, read a book, talk to your loan officer," Jeff Barron says. "Being a good businessperson today means accepting that financial statements are a vital aspect of your business. Successful business owners learn how to rely on these reports to track their successes and pinpoint weak areas."

Tax profit versus real earnings

Other business owners rely on their income statement (tax profit or loss) as a measuring stick for their business success. However, tax-based records do not provide an accurate picture of a business.

According to Wayne Bouchard, business consultant for First Pioneer Farm Credit in Claverack, N.Y. "A more precise measure of profit is 'real earnings,' which requires use of both the income statement and the balance sheet. The accounting term for real earnings is accrual earnings.

"Real earnings match income to the period they were earned and expenses to the period they were used. Real earnings take the tax planning and cash management monkey business out of your records to determine where you really are in relation to your goals."

You can refer to your income statement and balance sheet to see if your silo is full, if your bills are paid, if operating credit is available or if your business is stronger today than it was this time last year. For example, if two farmers both showed a $10,000 profit in 2001, can we say that both of their businesses were equally successful? At first glance, you might think so.

But their balance sheets show the real answers. The first farmer's silo is filled with $25,000 worth of corn and his accounts payable decreased during the year by $25,000. Meanwhile the other farmer had an empty silo and his accounts payable increased during the year by $125,000.

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By examining the real earnings of both farmers, you can see that their financial pictures are not equal. The first farmer is obviously in a much better position than the second farmer.

What financial statements tell you

Look over your financial statements at least quarterly to determine if your business is on track. For example:

• Are you meeting your income and expense goals?
• Are your accounts payables and accounts receivables within your budgeted ranges?
• Are you meeting your cash flow obligations without accumulating operating debt?

Many financial software packages,such as AgCHEK™, provide both tax- (cash-) based and real earnings- (accrual-) based financial statements. The income statements are tied to a cost basis balance sheet to help you keep track of changes in assets and liabilities. The cost basis balance sheet can help you track quarterly changes in bank account balances, accounts receivables, payables and loan balances.

Your balance sheet points out how your management decisions affect your business. For example, you can determine if your net worth is increasing or decreasing. With up-to-date numbers in front of you, you can take corrective action if you detect a dip in your net worth or you can determine how well positioned you are to encounter a down cycle in your industry.

Spotting trends

For better decision making

You can use financial reports to make important business decisions throughout your life - from growing your business to transferring it to the next generation. At every important crossroad, you can look at these reports to evaluate your business and make the right decision.

Help is available

We recognize that you are experts in your businesses. You are the best at fishing; raising livestock; growing crops, flowers, shrubs or trees; harvesting timber or providing any of agriculture's food and fiber products to the Northeast and the world.

At Farm Credit, we are financial experts, and we want to help. If you are stuck with any phase of financial statements — from creating them, to maintaining them, to interpreting them, to using them to run your business — give your Farm Credit loan officer, record-keeping specialist or tax specialist a call today.

These expert professionals are ready — and eager — to help you get started, whether you already use computerized reports or simply track your business by monitoring your checkbook.

For additional help, click here.

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