FINANCIAL STATEMENTS

It includes the cash flow statement, balance sheet and income statement.

CASH FLOW STATEMENT

It is also called as the sources and uses of funds or flow of funds statement. Both the cash inflows and out-flows are summarized over a given period of time. Moreover, it is prepared either for a farm business or to a farm operator’s family. In a cash flow statement the total cash inflows must equal to the total cash out flows. The total cash inflows include; (i) total cash available which excludes borrowings, (ii) new operating loans, and (iii) new medium and long-terms loans as well as the consumption loan. Likewise, the total cash outflows consist of; (i) total cash required which excludes principal repayments, (ii) principal repayments and (iii) ending cash balance.

The problem of untimely repayment of loan instalments can be diagnosed and resolved by the cash flow statement of a farm business. Infact, an estimation of source wise cash income and month wise cash expenses provide the month wise deficit or surplus information. Thus, from an annual cash flow, a farmer can foresee when he will actually need the loan and when he will be able to repay it. This is particularly important when he is required to pay a high rate of interest and when loans are available at all times. A cash flow also helps the farmer in checking his farm expenses and in assessing the possibility of reducing his costs.

BALANCE SHEET

Knowledge of the owner’s equity or of the net worth of the borrower is helpful in assessing the security of loans and the risk involved in advancing loans. The “balance sheet” also called as “net worth or financial statement”, is a summary of assets and liabilities of a business together with the statement of the owners equity or net worth. The term “balance” here implies that the value of assets must equal to the value of liabilities plus owner’s equity or net worth. Balance sheet characteristics are

1. It pertains to specific point of time, i.e., 31st December 2006. In fact, the date should be chosen such as two successive balance sheets represent the beginning and ending points of time as covered by the intervening income statement. It may correspond the agricultural year, calendar year or financial year.

2. It characterizes the three essential components, viz., (a) assets (b) liabilities and (c) net worth or owner’s equity, the balancing entry in the account.

3. It includes either owned or owed items and does not provide an accurate measure of total assets controlled, since many assets used in the production may be rented in.

4. The balance sheet can be prepared for a “farm business” or for a “farm operator’s family” (includes both business and personal items). These assets and liabilities are presented in order of payments/liquidity. Moreover, the liabilities are written on left side while assets towards right side.

5. The balance sheet does not indicate the progress or deterioration of the farm business, unless drawn overtime and net worth is compared.

6. The balance sheet can be constructed on a cost basis/book value (purchase price or original cost minus depreciation) or current market value basis.

7. Sometimes the physical data is also given to see the changes in inventory value (quantity of grain or size and number of livestock), changes in unit prices or changes in both inventories and prices.

Liability: - It represents an amount which is owed to others whether payable in cash, kind or services.

Current liability:- are debts payable within the operating year (normally 12 months) e.g. crop loan. Accrued interest on loans owed i.e., short, medium and long term, in the year the statement is prepared, loan instalments of medium and long term loans due within the next 12 months are considered as the current liability. Just like operating loans, the payments for medium and long term loans must come from the sale of current assets.

Intermediate/medium-term and long term liabilities:- There are the obligations associated with the intermediate and long term assets, respectively. One should consider outstanding principal which is due beyond 12 months as intermediate or longterm liability. Medium term loans/liability are those whose maturity between 1 and 7 years while long term loans/liability possess maturity is more than 7 years.

Contingent liability:- These become due under specific circumstances, such as capital gain taxes. Such taxes become due only when the capital asset is sold. Such liabilities are only accounted for if the balance sheet is prepared on market value basis.

Asset:- These represent the value that are owned and classified according to time required to convert them into cash with a minimum loss, i.e., current, medium and long-term assets. Moreover, the assets are listed in sequence of their liquidity.

a) Current assets:- These are consumed within the single year and can be converted into cash without disrupting the farm business (sale of land disrupts the farm business).

b) Medium term assets:- These assets cannot be converted or sold for cash in short period of time, e.g., milch and draught animals, small equipments, etc. These assets are not consumed within the year and continue to give returns beyond one year.

c) Long term or fixed assets:- These are also part of production plan but are of permanent nature. Farm real estate represents the major long term asset on the balance sheet for most farm operators.

d) Net worth:- The owner’s equity or net worth represents the residual entry in the account which “balances” the statement.

Financial tests and ratios

The financial ratio analysis can also be done based on balance-sheet data which monitors the financial structure of the farm business or farm operator. These financial ratios provide information pertaining to extent of risk involved in lending to the farmer and can be divided as (a) liquidity ratios, and (b) solvency ratios.

(A) Liquidity ratios: - These ratios indicate the ability of the farmer to generate sufficient cash in order to meet the debt obligations without disrupting his farm business. These are:

(i) Current ratio = current assets / current liabilities

This ratio indicates the extent to which current assets, if liquidated, would cover the current liabilities, i.e., the value of current assets for each rupee of current liability. The higher current ratio means more liquidity exists in the farm business.

(ii) Working ratio = Sum of current plus working assets / Sum of current plus working liabilities : This ratio reflects that whether or not the cash derived in this period would be adequate to cover the liabilities of the same period. Higher ratio, being more than one, indicates that the risk-bearing ability of the borrower is adequate.

(iii) Debt-structure ratio = Current liabilities / Total liabilities : Lower the value of this ratio, higher is the liquidity position of the farm business.

(iv) Acid test ratio or quick ratio = Current assets minus inventories and supplies / Current liabilities: This ratio reflects the adequacy of cash, accounts receivable, etc. to cover all current liabilities.

(B) Solvency ratios: - Solvency is a measure of financial security, i.e. what would be left in case all the assets are converted into cash and debts are paid.

(i) Leverage ratio or debt-to-equity ratio = Total liabilities / Net worth: If the leverage ratio is higher, the farm operator has larger claims/debt to pay in relation to his equity.

(ii) Net capital ratio = Total assets / Total liabilities: A greater than one net capital ratio indicates that the liquidation of farm business would generate adequate cash to repay the total liabilities.

(iii) Equity-to-asset value ratio = Farmer’s equity or net worth / Value of assets

Since total assets = total debt + owner’s equity, leverage ratio, net capital ratio and equity to asset value ratio are alternative ways of expressing the overall leverage position of a farm business.

INCOME STATEMENT OR PROFIT AND LOSS STATEMENT

It is a measure of revenue and expenses during a specified accounting period (usually a year). It provides a fairly good picture of income earning and managerial ability of the farmer, in case drawn over a number of years. Moreover, an income-statement can be constructed either for a farm business or of a farm operator. Once prepared for a farm business, it reveals the success or failure story over time together with the costs and returns associated in the use of capital and/or credit.

Usually, the income statement considers the various types of income such as (a) cash revenue from sale of crops, livestock and its products, earnings from custom hiring and cash receivables, (b) kind income such as, value of farm produce consumed by the family, the rental value of farm dwellings, (c) unrealized income such as inventory changes, (d) miscellaneous sources, if any. However, the non-farm income can also be included in the income statement, if prepared for a farm operator. Normally, three income level figures, viz., net cash income, net farm income and returns to management, are to be considered while preparing the income statement.

Cash farm operating expenses represent those expenditures of cash which are associated with the operation of a farm. These include; the purchases of seed, feed, fertilizers, pesticides and supplies i.e. variable cash expenses are incurred only if production is undertaken. Fixed cash expenses represent the outlays incurred even in the absence of production, e.g., land revenue, interest on medium and long-term loans, etc. Expenditures on the purchase of capital assets such as tractor, bullocks, pumpsets, land, etc., are not considered as a cash expense because these assets are consumed over the period. In fact, the cost of these capital assets is allocated over their entire life by including annual depreciation as an expense item. Similarly, the current principal payment on loans is also excluded as cash expense since repayment of principal has no effect on profit as liabilities are reduced by an equal amount. However, the interest payments form a cash expense. These total cash farm expenses are deducted from the total cash farm revenues to get the net cash farm income.

The inventory of a farm may also differ between the beginning and at the end. Therefore, these changes may also be accounted for at the time of income measurement. In fact, the annual net change in crop and livestock inventories, fertilizer and other supplies must be accounted for if we are interested to measure the accurate profit. In case inventories are greater at the end of the year as compared to beginning of the year, then addition to farm income would be positive. Contrarily, if inventories declined during the year, the income would be reduced while doing non cash adjustments in the income statement. Similarly, changes in the value of crop and livestock inventories due to the changes in price should also be reflected when adjusted for the income. The changes between beginning and ending liabilities such as debt and interest payments may also be considered while preparing an income statement.

The non-farm income represents the net cash earnings of farm operator and his family from non-farm investments and occupations. This may also be included if we are preparing the income statement of a farm operator. Likewise, the value of farm produce consumed by the farmer and his family should be included while measuring the net farm earnings. By subtracting the imputed value of family labour and interest on the investment (or working capital) with the net farm earnings, one can get the returns to management of a farm business.

Financial tests and ratios

These ratios can be divided into two categories viz; (a) Efficiency ratios, which relate expenses to gross income, and (b) Profitability ratios, which relate income to the capital investment.

Efficiency ratios:- These ratios measure the degree to which a farm operator uses his farm resources in order to obtain the optimum results.

(i) Operating ratio = Total operating farm expenses / Gross farm income

It reflects the proportion of operating farm expenses into the gross farm income.

(ii) Fixed ratio = Total fixed farm expenses / Gross farm income

It represents the share of fixed farm expenses per rupee of gross farm income.

(iii) Gross ratio = Total farm expenses / Gross farm income

It expresses the proportions of gross farm income being absorbed by the total costs.

(iv) Expense structure ratio = Fixed cash expenses / Total cash expenses

Higher the value of expense structure ratio, the more inflexible the farm operator is to adjust quickly and efficiently with the changing market conditions.

Profitability ratios:- The rate of return on investment offers one criterion which can be applied across different types and sizes of farm businesses. Furthermore, income to investment ratios indicate the efficiency with which capital is being employed in the farm business.

(i) Capital turnover ratio = Gross income / Total capital investment

It measures the gross farm income generated per rupee of capital investment. It is used to quickly appraise the efficiency of capital.

(ii) Rate of return on debt and equity capital = Net return to capital / Total capital investment

It relates to the return from debt and equity capital invested in the farm business to the total farm business assets.

(iii) Rate of return on equity capital = Return to equity / Net worth

It describes the returns per rupee of equity invested and provides a basis for comparison with the rates of return on non-farm investments. Greater than one profitability ratios indicate that borrowed loan has generated the additional returns reflecting thereby the sound investment.