Chapter 6 The Income Statement & Its Analysis
<ul><li>Discuss purpose and use of an income statement </li></ul><ul><li>Illustrate the structure and format of an income ...
<ul><li>Income Statement:  summary of revenues and expenses for a given accounting period </li></ul><ul><li>Also called a ...
<ul><li>Include revenue earned  during  the accounting period only </li></ul><ul><li>Can be CASH or NONCASH </li></ul><ul>...
<ul><li>NOT ALL CASH RECEIPTS ARE REVENUES </li></ul><ul><li>NOT gift or inheritance </li></ul><ul><li>NOT a loan from the...
<ul><li>Gain or loss on sale of capital assets:  difference between sales price and the cost of the capital asset for land...
<ul><li>Can be CASH or NONCASH </li></ul><ul><li>NONCASH </li></ul><ul><ul><li>Ex: depreciation, accounts payable, accrued...
<ul><li>NOT EVERY EXPENDITURE OF CASH IS AN EXPENSE </li></ul><ul><li>NOT cash expenditures for clothes, gifts… </li></ul>...
<ul><li>Total Revenue </li></ul><ul><li>-Total Expenses </li></ul><ul><li>Net Farm Income from Operations </li></ul><ul><l...
<ul><li>FFSC encourages use of Accrual Accounting  </li></ul><ul><li>However, a majority of farmers and ranchers use Cash ...
<ul><li>If a business shows a Profit for the year, is it a Profitable business? </li></ul><ul><li>Profitability:  concerne...
<ul><li>Net Farm Income:  amount by which revenues exceeds expenses, plus an gain or loss on the sale of capital assets </...
<ul><li>1.) RATE OF RETURN ON ASSETS </li></ul><ul><li>2.) RATE OF RETURN ON EQUITY </li></ul><ul><li>3.) OPERATING PROFIT...
<ul><li>Also noted ROA or ROI </li></ul><ul><li>Use a % to compare with other farms </li></ul><ul><li>ROA (%) =  Return to...
<ul><li>Numerator </li></ul><ul><li>Net Farm Income from Operations </li></ul><ul><li>+ Interest Expense </li></ul><ul><li...
<ul><li>EXAMPLE from Table 6-2 (page 98) </li></ul>RATE OF RETURN ON ASSETS  Numerator Net Farm Income from Operations  $ ...
<ul><li>Denominator </li></ul><ul><li>Average Farm Asset Value is the average of beginning and ending total asset values f...
RATE OF RETURN ON ASSETS  ROA (%) =  Return to Assets($)   x  100 Average Farm Asset Value($)   =  $51,300   =  7.07% $725...
<ul><li>ROE is the return on the owner’s share of the capital invested </li></ul><ul><li>NO ADJUSTMENT FOR INTEREST EXPENS...
<ul><li>Numerator </li></ul><ul><li>Net Farm Income from Operations </li></ul><ul><li>-  Opportunity Cost of Labor </li></...
<ul><li>Numerator </li></ul><ul><li>Net Farm Income from Operations  $ 46,800 </li></ul><ul><li>-  Opportunity Cost of Lab...
RATE OF RETURN ON EQUITY ROE (%) =  Return on Equity($)   x  100 Average Equity($)   =  $21,800   =  6.03% $361,320
<ul><li>If ROA > i  then ROE > ROA </li></ul><ul><li>If ROA < i  then ROE < ROA </li></ul><ul><li>If ROA is greater than t...
<ul><li>Higher value means more profit per dollar of revenue </li></ul><ul><li>Operating Profit Margin Ratio =  Operating ...
OPERATING PROFIT MARGIN RATIO Numerator Net Farm Income from Operations + Interest Expense -  Opportunity Cost of Labor - ...
OPERATING PROFIT MARGIN RATIO Numerator Net Farm Income from Operations  $ 46,800 + Interest Expense +$ 29,500 -  Opportun...
OPERATING PROFIT MARGIN RATIO Operating Profit Margin Ratio =  Operating Profit   x 100   Total Revenue =  $ 51,300   =  2...
<ul><li>Dollar amount that represents the net farm income from operations to pay for operator labor and management after a...
<ul><li>Net Farm Income from Operations </li></ul><ul><li>+ Interest Expense </li></ul><ul><li>-  Opportunity Cost of all ...
<ul><li>Net Farm Income from Operations  $46,800 </li></ul><ul><li>+ Interest Expense   + $29,500 </li></ul><ul><li>-  Opp...
<ul><li>Owner withdraws </li></ul><ul><li>Increases in cash or other farm income </li></ul><ul><li>Reduction in liabilitie...
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Packet #6

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Packet #6

  1. 1. Chapter 6 The Income Statement & Its Analysis
  2. 2. <ul><li>Discuss purpose and use of an income statement </li></ul><ul><li>Illustrate the structure and format of an income statement </li></ul><ul><li>To define the sources and types of revenue and expenses that should be included on an income statement </li></ul><ul><li>To show how profit, or net farm income, is computed from an income statement, and what it means and what it measures </li></ul><ul><li>To analyze farm profitability by computing returns to assets and equity and by studying other measures of profitability </li></ul>Objectives
  3. 3. <ul><li>Income Statement: summary of revenues and expenses for a given accounting period </li></ul><ul><li>Also called a Profit and Loss Statement </li></ul><ul><li>FFSC prefers term Income Statement </li></ul><ul><li>Measures the profit of a business </li></ul><ul><li>1 st identify revenues and expenses </li></ul>Income Statement
  4. 4. <ul><li>Include revenue earned during the accounting period only </li></ul><ul><li>Can be CASH or NONCASH </li></ul><ul><li>NONCASH </li></ul><ul><ul><li>Ex: inventory, accounts receivable, value of feed or livestock received in payment for custom work </li></ul></ul>Revenues
  5. 5. <ul><li>NOT ALL CASH RECEIPTS ARE REVENUES </li></ul><ul><li>NOT gift or inheritance </li></ul><ul><li>NOT a loan from the bank </li></ul><ul><li>NOT non-farm income </li></ul><ul><li>ONLY revenue from the production of agricultural commodities, services performed, and the gain or loss on the sale of assets used in that production </li></ul>Revenues
  6. 6. <ul><li>Gain or loss on sale of capital assets: difference between sales price and the cost of the capital asset for land and the difference between the selling price and the asset’s book value for depreciable assets like a truck. </li></ul><ul><li>Gain or loss on sale of capital assets should be included in the revenue section </li></ul>Gain or Loss on Sale of Capital Assets
  7. 7. <ul><li>Can be CASH or NONCASH </li></ul><ul><li>NONCASH </li></ul><ul><ul><li>Ex: depreciation, accounts payable, accrued interest, and other accrued expenses </li></ul></ul><ul><li>Include an adjustment for Prepaid Expenses </li></ul><ul><li>FFCS recommends that income taxes are included on statement </li></ul><ul><li>Will not include them in class due to the difficulty to estimate, particularly when there is off-farm income </li></ul>Expenses
  8. 8. <ul><li>NOT EVERY EXPENDITURE OF CASH IS AN EXPENSE </li></ul><ul><li>NOT cash expenditures for clothes, gifts… </li></ul><ul><li>NOT principle on loans, but would include interest expense </li></ul><ul><li>ONLY business expenses for items required to produce agricultural commodities and services </li></ul>Expenses
  9. 9. <ul><li>Total Revenue </li></ul><ul><li>-Total Expenses </li></ul><ul><li>Net Farm Income from Operations </li></ul><ul><li>+/- Gain or Loss on Sale of Capital Assets </li></ul><ul><li>NET FARM INCOME </li></ul>Income Statement Format
  10. 10. <ul><li>FFSC encourages use of Accrual Accounting </li></ul><ul><li>However, a majority of farmers and ranchers use Cash Accounting which can be misleading and result in poor decisions </li></ul><ul><li>FFSC recommends converting the Cash-Basis income statement to an Accrual-Adjusted Net Farm Income at the end of the year </li></ul>Accrual Adjustments to a Cash-Basis Income Statement
  11. 11. <ul><li>If a business shows a Profit for the year, is it a Profitable business? </li></ul><ul><li>Profitability: concerned with the size of the profit relative to the size of the business, or the value of resources used to produce the profit </li></ul><ul><li>In other words, a business can show a profit but have a poor profitability rating if this profit is small relative to the size of the business. </li></ul><ul><li>Ex: 2 farms with the same net farm income are not equally profitable if one used twice as much land, labor, or capital to produce that profit. </li></ul>Net Farm Income Analysis
  12. 12. <ul><li>Net Farm Income: amount by which revenues exceeds expenses, plus an gain or loss on the sale of capital assets </li></ul><ul><li>Amount available to the operator for unpaid labor, management, and equity capital used to produce that net farm income </li></ul><ul><li>Absolute dollar amount, thus it is difficult to assess profitability </li></ul>Net Farm Income
  13. 13. <ul><li>1.) RATE OF RETURN ON ASSETS </li></ul><ul><li>2.) RATE OF RETURN ON EQUITY </li></ul><ul><li>3.) OPERATING PROFIT MARGIN RATIO </li></ul><ul><li>4.) RETURN TO LABOR & MANAGEMENT </li></ul>4 Methods to Measure Profitability
  14. 14. <ul><li>Also noted ROA or ROI </li></ul><ul><li>Use a % to compare with other farms </li></ul><ul><li>ROA (%) = Return to Assets($) x 100 </li></ul><ul><li>Average Farm Asset Value($) </li></ul>RATE OF RETURN ON ASSETS
  15. 15. <ul><li>Numerator </li></ul><ul><li>Net Farm Income from Operations </li></ul><ul><li>+ Interest Expense </li></ul><ul><li>- Opportunity Cost of Labor </li></ul><ul><li>- Opportunity Cost of Management </li></ul><ul><li>Return to Assets </li></ul><ul><li>Denominator </li></ul><ul><li>Average Farm Asset Value is the average of beginning and ending total asset values from the Balance Sheet </li></ul>RATE OF RETURN ON ASSETS
  16. 16. <ul><li>EXAMPLE from Table 6-2 (page 98) </li></ul>RATE OF RETURN ON ASSETS Numerator Net Farm Income from Operations $ 46,800 + Interest Expense +$ 29,500 - Opportunity Cost of Labor - $ 20,000 - Opportunity Cost of Management - $ 5,000 Return to Assets $ 51,300
  17. 17. <ul><li>Denominator </li></ul><ul><li>Average Farm Asset Value is the average of beginning and ending total asset values from the Balance Sheet </li></ul><ul><li>If the value on Dec. 31, 2002 was $741,500 and was $710,000 on Jan.1, 2002, the Average Farm Asset Value would be $725,750 </li></ul>RATE OF RETURN ON ASSETS
  18. 18. RATE OF RETURN ON ASSETS ROA (%) = Return to Assets($) x 100 Average Farm Asset Value($) = $51,300 = 7.07% $725,750
  19. 19. <ul><li>ROE is the return on the owner’s share of the capital invested </li></ul><ul><li>NO ADJUSTMENT FOR INTEREST EXPENSE </li></ul>RATE OF RETURN ON EQUITY ROE (%) = Return on Equity ($) x 100 Average Equity ($)
  20. 20. <ul><li>Numerator </li></ul><ul><li>Net Farm Income from Operations </li></ul><ul><li>- Opportunity Cost of Labor </li></ul><ul><li>- Opportunity Cost of Management </li></ul><ul><li>Return on Equity </li></ul><ul><li>Denominator </li></ul><ul><li>Average Equity is the average of beginning and ending market or cost basis equity for the year </li></ul>RATE OF RETURN ON EQUITY
  21. 21. <ul><li>Numerator </li></ul><ul><li>Net Farm Income from Operations $ 46,800 </li></ul><ul><li>- Opportunity Cost of Labor - $ 20,000 </li></ul><ul><li>- Opportunity Cost of Management - $ 5,000 </li></ul><ul><li>Return on Equity $ 21,800 </li></ul><ul><li>Denominator </li></ul><ul><li>Assume an average market basis of $361,320 </li></ul>RATE OF RETURN ON EQUITY
  22. 22. RATE OF RETURN ON EQUITY ROE (%) = Return on Equity($) x 100 Average Equity($) = $21,800 = 6.03% $361,320
  23. 23. <ul><li>If ROA > i then ROE > ROA </li></ul><ul><li>If ROA < i then ROE < ROA </li></ul><ul><li>If ROA is greater than the interest rate paid on borrowed capital, this extra margin or return above interest cost accrues to equity capital </li></ul>RATE OF RETURN ON EQUITY
  24. 24. <ul><li>Higher value means more profit per dollar of revenue </li></ul><ul><li>Operating Profit Margin Ratio = Operating Profit x 100 </li></ul><ul><li> Total Revenue </li></ul>OPERATING PROFIT MARGIN RATIO
  25. 25. OPERATING PROFIT MARGIN RATIO Numerator Net Farm Income from Operations + Interest Expense - Opportunity Cost of Labor - Opportunity Cost of Management Operating Profit Denominator Total Revenue
  26. 26. OPERATING PROFIT MARGIN RATIO Numerator Net Farm Income from Operations $ 46,800 + Interest Expense +$ 29,500 - Opportunity Cost of Labor - $ 20,000 - Opportunity Cost of Management - $ 5,000 Operating Profit $ 51,300 Denominator Total Revenue $200,400
  27. 27. OPERATING PROFIT MARGIN RATIO Operating Profit Margin Ratio = Operating Profit x 100 Total Revenue = $ 51,300 = 25.6% $200,400 ***Meaning that on the average, every dollar of revenue generates 25.6 cents after paying the operating expenses
  28. 28. <ul><li>Dollar amount that represents the net farm income from operations to pay for operator labor and management after all capital is paid a return equal to its opportunity cost </li></ul>RETURN TO LABOR & MANAGEMENT
  29. 29. <ul><li>Net Farm Income from Operations </li></ul><ul><li>+ Interest Expense </li></ul><ul><li>- Opportunity Cost of all Capital </li></ul><ul><li>Return to Labor and Management </li></ul>RETURN TO LABOR & MANAGEMENT
  30. 30. <ul><li>Net Farm Income from Operations $46,800 </li></ul><ul><li>+ Interest Expense + $29,500 </li></ul><ul><li>- Opportunity Cost of all Capital - $58,060 </li></ul><ul><li>Return to Labor and Management $18,240 </li></ul><ul><li>Assume OC capital is 8% </li></ul><ul><li>OC capital is 8%($725,750) = $58,060 </li></ul>RETURN TO LABOR & MANAGEMENT
  31. 31. <ul><li>Owner withdraws </li></ul><ul><li>Increases in cash or other farm income </li></ul><ul><li>Reduction in liabilities </li></ul>Change in Owner Equity

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