Chapter 3

Farm Records and Analysis

Farm business analysis is the name given to a technique based on computation and interpretation
of a variety of efficiency measures for the farm under study.
The results of the analysis are then compared with standards derived from a group of farms of
similar size and type. This comparison is then used to highlight organizational weaknesses and
strengths of the farm business.
If farm accounts are available, this system of farm business analysis can be a useful tool.
The subject of farm business analysis is dealt under different names, i.e. farm accountancy, farm
records and accounts or farm book keeping. Their objective is basically the same but the
difference lies in the methods of treatment or approaches.
Farm accountancy is defined as the art and science of recording business transactions in books
in a regular and systematic manner so that their nature, extent and financial effects can be readily
ascertained at any time of the year.
Farm book keeping is known as a system of records written to furnish a history of the business
transactions, with special reference to its financial side.
Farm accounting, in the usual sense is an application of the accounting principles to the
business of farming.
The main objectives of farm business analysis are to answer such questions as:
 How does the business perform at a certain time?
 Where are the weaknesses?
 What Improvements are possible?
There are some subsidiary objectives too, such as providing background information for farm
policies and for getting credit facilities.
The three major steps or stages of farm business analysis are:
 Keeping proper recording of accounts and activities
 Analysis and interpretation of the results
 Presentation of results
Advantages of farm records and accounts
1. It is a means to higher income.
To obtain higher income, farmers must have good knowledge about present and potential
gross income and operating costs. The best way to obtain such knowledge is to keep
records and accounts. Keeping records and accounts would enable the farmer to:
 Know the financial status of his farm at a point in time;
 Know the magnitude and sources of gains or losses over time;
 Identify the better sources of income and items of costs;
 Keep a check on unproductive expenditures
 Examine comparative profitability of and costs involved for different enterprises;
etc.
The combined knowledge of all these enables the farmer increase his income.
2. It is a basis for diagnosis and planning.
Diagnosis of management problems is the prerequisite of sound planning. Records and
accounts provide the basic information needed for identifying the sources of problems.
3. It is a way to improve managerial ability.
It helps to acquire business habits which can be of help in taking advantage of changes in
the economic environment. The farmer gets a better insight into his business which helps
him in finding out the defects, which can be set right by exercising better control and
effective economies. In addition, farmers can avoid mistakes and losses that usually
arise from dependence only on his memory of guidance.
4. It is a basis for credit acquisition and management.
Properly kept records and accounts can demonstrate and authenticate the production and
income potentials and credit worthiness of the farmer. Thus, lending agencies can help
the farmer in meeting his credit needs more readily and he/she can manage his/her credit
utilization properly.
5. It guides to a better management and future decisions.
Farm records and accounts provide information on farm-household economy. This is
especially important in the rural areas of Ethiopia where farm and home management are
so closely integrated. Analysis of farm records provides good guides for the allocation of
resources between production improvement and immediate family welfare.
6. It is a basis for research.
Research requires precise and correct data which is possible only if proper records and
accounts are maintained on the farms included in the study.
7. It is a basis for policy formulation
Farmers need to continuously feed the facts for state and national policy makers.
Appropriate policies on the issue of land, price, crop insurance policies, etc can be
designed by using these facts and based on the objective reality of the farms. Records
and accounts are, thus, inputs for understanding the fact and for examining and
developing sound policies.
Problems and difficulties in farm accounting
Most of the Ethiopian farmers do not know how to maintain farm accounts due to lack of
education, business orientation and time required to do this job. Some specific difficulties
include:
1. Subsistence nature of farming
Farming as a business is relatively a small size operation in Ethiopia. Farmers cannot
engage a trained accountant or farm manager for helping them in farm accounting. The
subsistence nature of farming does not produce enough incentive for keeping the records.
2. Farming is a laborious work
Farming requires a lot of physical labor, in addition to the mental work of the
management. In the daily routine, the farmer usually gets exhausted in the evening and
does not feel like sitting at the desk to complete the records and accounts.
3. Triple role of farmers
Ethiopian farmers (head of the farm household) play a triple role in running their farm
business, i.e; that of a manager, a financer and a laborer. The farmer needs, therefore, to
know his wage as a laborer, his returns to capital and to his management role. Such
complex records which would give information are difficult to maintain.
4. Illiteracy and lack of business awareness
The very low level of literacy among the Ethiopian farmers is one of the factors that
hinder the development of the required level of business awareness on the part of the
producers as they do not realize the need for records and accounts.
5. Complicated nature of agribusiness
 Agricultural business is a biological industry and is always subject to weather and other
natural uncertainties. It requires an accounting system which can handle various
complexities involved in the business of farming. Such complicated accounts are difficult
to maintain.
6. Inadequate extension service
Sufficient number of trained specialists in farm management who could help farmers
maintain account of their business are not available.
7. Non-availability of suitable farm record books
Lack of standardized, easy to understand and maintain account books also stand in the
way of willingness of the producers or farmers to keep records. Standard farm record books
need to be developed and they should be simple and easy to understand and available in
local languages.
8. Fear of taxation
Farmers are always afraid of taxes. They fear that if they maintain records and accounts
and their incomes show up high, some sort of tax may be levied on them.
Parts of farm records
Because of the diversity of the farm situations, not all records will be of equal use on all farms.
The kinds of records to keep will depend upon what information one wishes to have.
There are three parts of farm record system: Physical farm records, financial farm records and
Supplementary farm records.
Physical farm records
Physical farm records are related to the physical aspects of the operation of a farm business. It
simply records the physical efficiency or performance of the farm. To implement the financial
records and the financial decisions, the physical data recording concerning the farm and its
performance are essential.
The main use of physical farm records is:
 To check performance of enterprises,
 For controlling business,
 To detect weaknesses and strengths to guide future decisions,
 To provide planning and budgeting data
Physical farm records normally include the following: farm map, contour map, land utilization
records; crop production and disposal records; livestock production and disposal records, labor
records, daily work diary, machine use records, feed records etc.
Financial records
These records are mainly related to the financial aspects of the operations of a farm business.
They are required to provide information regarding the profitability of the whole farm business
over a given period. In addition, financial records enable financial analysis to be carried out to
reveal the economic strengths and weaknesses of the farming system, and to provide data to help
in the preparation of revised plans and budgets. The financial record may include farm cash
records, capital assets, cash and credit sale register, purchase register, wage register, fund
borrowed and repayment registers, farm expenses paid in kind register and non-farm income
register.
Supplementary records
Examples: Sanction register, rainfall register, stationary register, auction register and hire
register.
The main characteristics of a good farm record book
i. It should be simple and easy to understand
ii. It should be suitable forms for recording the type of information the farmer wants to
record;
iii. It should have provision for an itemization and classification of all entries;
iv. It should have adequate space for itemizing all entries ,and the lines and spaces
sufficiently wide for writing without crowding
v. It should have adequate instructions for recording and analysis of the recorded data.
Farm inventory valuation / analysis
Farm inventory is a list of all properties of a business along with their values at a specified date.
In other words, it is the complete list of farmer`s assets. It is the first step in farm accounting.
The purposes of preparing farm inventory are the following:
1. A complete farm inventory, taken at the beginning of each season, will give a list of
all the assets with their values. It shows what amount of capital accumulation goes
back into the business. The farm inventory is a necessary step in complete farm
accounting.
 2. It reveals the changes in net worth through comparison of a farm inventories taken at
the beginning of the year with another assembled at the end of the year. The inventory
provides a basis for computing growth in net worth.
3. It enables you to work out the measures of income. Certain management or efficiency
measures depend on accurate inventory.
4. It enables to determine the depreciation costs.
5. It serves as a basis of income statement and balance sheet. It provides net income data
and serves as a basis for farm business analysis.
Assets
Asset is anything of value owned by a business. Assets have value for one or both of two
reasons.
 It can be sold to generate cash/income.
 It can be used to produce other goods which can be sold to provide cash income
at some future time.
Types of assets
1. Liquid assets- those assets that can easily and quickly sold at their full market price
with out disrupting the future production activities. Example: cash, recievables, bank
balance, grain, feeder livestock.
2. Illiquid/less liquid assets-assets owned primarily to produce future income. Selling
them to generate cash to meet current obligations would affect the firm`s ability to
produce future income. Example: machinery, breeding livestock, building, land.
Assets can be classified into three based on liquidity and useful life.
1. Current assets-assets which will liquidate in normal operation of the business within
the accounting year. They are used up or sold in the accounting year. Their sale will
not disrupt future production activities. Example: cash on hand. Readily marketable
stocks and bonds, grain, feed, feeder livestock, cash value of life insurance, prepaid
expense, value of growing crop.
2. Working /intermediate assets-intermediate in liquidity and useful life have useful
life between 1 and 10 years. Selling these assets affects the future income potential of
the business. Example: machineries, equipment, breeding livestock.
 3. Fixed assets-assets that are more difficult to convert them into cash easily to meet
any current obligation. The least liquid assets. Assets which have useful life of greater
than 10 years. Selling these assets would seriously affect the on-going nature of the
business. example: real estate/ land permanent building and land. If all the land and
buildings were sold, the business might be totally eliminated making the business
unable to continue.

Farm Financial Analysis

Financial analysis involves maintaining and using records and other information needed to
measure the financial performance of a business. Farm financial analysis is a statement that
shows the financial conditions of the business at a particular point of time.
The most widely used financial statements are: farm balance sheet (net worth statement) and
farm income statement (profit-loss statement).
Balance sheet and its analysis
Balance sheet is a summary of the assets and liabilities of the business, together with a statement
of the owner`s equity or net worth at a given point in time. It is a systematic organization of
everything ``owned`` and ``owed`` by a business or individual at a given point in time.
Anything of value owned by a business or individual is an asset. Any obligation or debt owed to
someone else is called liability.
Balance sheet also shows the net worth or owner`s equity which is the difference between total
assets and total liabilities.
A balance sheet can be computed any time during the year, but the usual time is at the end of the
accounting period (generally December 31).
The primary use of the balance sheet is to measure the financial strength and position of the
business. Its primary function is to measure risk bearing ability or financial solvency; i.e it shows
the margin by which debt obligations would be covered if the business was terminated and all
assets sold.
Asset=liabilities+owner`s equity
The general format of the balance sheet
Assets Liabilities
Current assets x Current liabilites x
 Intermidiate assets x Intermidiate liabilities x
Fixed assets x Long term liabilites x
Total liabilities xx
Net worth xx
Total assets xx Liabilities and net worth xx
Several measures of financial strength and position of the business can be obtained from a
balance sheet. These are:
1. Solvency-measures whether assets total are greater than total liabilities. If not, the
business is insolvent or technically bankrupt. Measures the ability of the business to
pay all obligations from the sale of the assets.
2. Liquidity –measures the ability to generate cash needed to meet cash obligations
without seriously disrupting the production activities of the business.
3. Net worth or owner`s equity-the amount of money remaining for the owner of the
business after liquidating the business and paying all liabilities.
Liability
It is any obligation or debt that has to be paid to someone else. It represents an outsider`s
claim against one or more of the business assets. Example: debt, tax, interst, rent, salary.
There are three types of liabilities depending on the time or length of loan.
1. Current liabilities-the financial obligation which will be due with one year or less
from the date of balance sheet. Example: pay roll obligation (salary), account
payables, accrued tax/rent/interest, insurance.
2. Intermediate liabilities-loans used for purchase of working assets. Repayment is
between 2 and 10 years. Example: machinery, breeding livestock. However, any
principal that will be due within the current year and accrued interest would be listed
as current liability with the remaining balance entered as intermediate liability.
3. Long term liabilities- loans used to purchase long term assets. Repayment is more
than 10 years. However, any principal and accrued interest that has to be due within
the current year would be listed as current liability.
Ratio analysis
Ratios provide a standard unit of measurement and also permit comparison overtime
and between firms of the same size. The actual ratios can be compared against goals
 or standards to perform the control function of management and deviations from these
goals are easily observed.
Major balance sheet ratios are: net capital ratio, current ratio, working ratio and
debt/equity ratio.
Example; consider the following balance sheet statement, on December.31.
Assets Liabilities
Current assets 55000 Current liabilities 48000
Intermediate assets 70000 Intermediate liabilities 27000
Fixed assets 115000 Long term liabilities 80000
Total liabilities 155000
Net worth 80000
Total assets 240000 Liabilities and net worth 240000

1. Net capital ratio (NCR) - measures the over all financial strength and solvency of the
business. The higher the ratio the safer and less vulnerable to unexpected drop in value
Total Assets
of the asset. NCR=
Total liabilities
If NCR>1; the business is safer and solvent. If NCR=1; the business is just solvent but not
safer. If NCR<1; the business is insolvent.
240000
Example: NCR= =1.55
155000
A NCR, which has been increasing from year to year, indicates the business is making
financial progress.
2. Current ratio (CR)-measures the liquidity of the business. It measures the ability of
the business to generate cash within the current year to meet cash payment on debts
Current Assets
and other current obligations.CR= Higher ratios are prefered.If
Current liabilities
CR>1; the business is liquid. If CR<1; the business is illiquid.
55000
Example: CR= =1.15
48000
3. Working ratio (WR)-an intermediate measure of both liquidity and solvency. The
higher the ratio the safer the business to be liquid and solvent in the intermediate
Current Assets+ Intermediate Assets
period. WR=
Current liabilities + Intermediate Liabilities
The firm can be solvent but not liquid. In this case, the firm will borrow against
intermediate and long term assets or sell these assets to pay current cash obligations.
55000+70000
Example: WR= =1.67
48000+27000
4. Debt/Equity Ratio (D/R)-measures of solvency which shows the relationship of
owned capital to borrowed capital. The smaller the ratio indicates the stronger the
Total liabilities
financial position of the business. D/R=
Owner s Equity
If D/R=1; liabilities equals net worth. The assets double liabilities (total assets=total
liabilities). It indicates the stronger the financial position and solvency of the business.
155000
In this case, NCR=2. Example: D/R = =1.82
80000
Income Statement and its Analysis
Income statement is a summary of income/receipts and expenses over a given time period
and shows the financial performance of a business. It is called as operating statement or
profit and loss statement. Its primary purpose is to compute profit for a given time period.
Some income statements may also include non-farm income and therefore show the total
annual net income for the farm family. An income statement provides a measure of return
from the business or the ability to meet financial obligations such as debt payment, rent,
payroll and other expenses. The income statement reveals the success or failure of a farm
business over time. Preparation and analysis of an income statement for a certain farm
business can be accomplished using lists of the receipts and the expenditures made during
that accounting period.
Receipts-are derived from sale of products and miscellaneous sources. Any farm
products used in the home should be valued and included in the receipts. For the purpose
of financial analysis, receipts from the sale of assets such as real estate or machinery are
generally not considered as income since such income is not really produced or earned
during the year.
Expenses-all expenses or costs involved in the operation of the business during the
period covered. All variable /operating and fixed expenses are entered. Capital
expenditures like purchase of fixed and working assets such as real estate, machinery and
breeding livestock are excluded since such items usually are used in the business for
several years. The depreciation that occurs on these items during the period covered by
the income statement is an expense and should be included.
Net income-the net income or loss figures are useful in the analysis of the business which
can be divided into net cash income, net operating income and net farm income.
Net cash income-cash receipts less cash expenses during the year covered by the income
statement excluding purchases and sales of capital assets. It provides an indication of the
annual net cash flow of the business. It is useful in preparing the income tax return when
it is made on the cash basis.
Net operating income- is gross income less operating expenses. It facilitates the
comparison of farms with various fixed-cost structures such as different mortgage debt
and depreciation schedules. It facilitates comparing operating income on the same farm
over a period of years.
Net farm income-net operating income less fixed costs.it represents an income accruing
to operating and family labor, management and equity capital. Of the three measures of
income, it is perhaps the most useful.
Income statement, December, 31, 2009.
1. Receipts(cash income)
Livestock sale------------------------------------------Birr x
Crop sale------------------------------------------------Birr x
Other cash income--------------------------------- --Birr x
Gross income---------------------------------------------------------Birr xx
2. Variable/operating expenses
Livestock expenses-----------------------------------Birr x
Crop expenses-----------------------------------------Birr x
Gasoline,fuel,oil----------------------------------------Birr x
Labor----------------------------------------------------Birr x
Others ---------------------------------------------- ----Birr x
 Total operating expenses--------------------------------------- ---Birr xx
3. Net operating income (1-2)---------------------------------------Birr xx
4. Fixed expenses
Propery tax---------------------------------------------Birr x
Insurance ----------------------------------------------Birr x
Non-cash expenses
 Depreciation on buildings, machineries--------Birr x
Total fixed costs/expenses--------------------------------------Birr xx
5. Net farm income (3-4)------------------------------------------ Birr xx

Financial ratio analysis of income statement

Income statement ratios can be divided into two categories.
1. Those that relate expenses to gross income
2. Those that relate income to capital investment
Expense to income ratios- Measure the input-output efficiency of the business. i.e.,
they measure the margin by which the value of total production exceeds the
production costs.
a) Operating ratio (OR)-shows the percentage of gross income used to cover
Total Operating Expenses
operating costs. OR=
Gross Income
b) Fixed ratio (FR) - shows the percentage of gross income used to cover fixed costs.
¿ Expenses
FR=
Gross Income
c) Gross ratio (GR) - shows the percentage of gross income used to cover total costs.
Total Expenses
GR=
Gross Income
Income-to-investment ratios-indicate the efficiency with which capital is being
employed in the business.
a) Capital turnover-commonly used as a quick appraisal of efficiency of capital
Gross Income
use. Capital turnover = where average capital investment is
Average Capital Investment
average of beginning and end of the year total assets.
 b) Return to capital (return on investment)-measures profitability.
¿
Return to Capital = Return ¿ Total Capital Total Farm Assets
¿
Rate of Return to Capital = Return ¿ Total Capital Total Farm Assets ∗100 %

Return to capital is the return to both debt and equity capital. Therefore, net farm income must be
adjusted. The interest on debt capital was deducted as an expense in calculating net farm income.
This interest then must be added back to net farm income before the return to capital is
computed. In other words, we calculate what net income would have been if no borrowed had
been used and then proceed to compute return to all capital.
Adjusted net farm income=income farm income +interest paid
Further adjustments are necessary, as adjusted net farm income still includes the return to the
owner`s labor and management as well as the return to all capital.
Return to capital = adjusted net farm income – (opportunity cost of labor+opportunity cost of
management)
c) Return to labor and management=adjusted net farm income-(opportunity cost on
total capital)
Return to labor =return to labor and management-opportunity cost of management
Return to management =return to labor and management-opportunity cost of labor
d) Return to equity-the business owner may be more intersted in the return to
personal or equity capital invested in the business.
Return to equity=net farm income-(opportunity cost of labor and management)
¿
Rate of return to equity= Return ¿ Equity Net Worth

Farm efficiency measures

Efficiency is defined as the ratio of output to input. It shows how much profitable the farming
business is. Efficiency measures help to point out the weaknesses in the farm business and
provide a guideline as to which part of the business deserves special attention for making
improvements. They also help realize the strong points of the farm organization which may be
further strengthen.
There are two types of efficiency measures. These are:
1. Physical efficiency measures
2. Value /financial efficiency measures
 Both physical and financial efficiency measures have aggregate/absolute and ratio
measures.
Physical efficiency measures
a) Aggregate measures 1. Total area of the farm 2. Number of livestock owned 3.
Total production
b) Ratio measures
I) Land use efficiency 1. Yield per hectare 2. Production efficiency 3. Crop yield
index 4. Intensity of cropping 5. Percentage of land under selected crops.
II) Labor efficiency 1. Crop land (ha)/man 2. Productive man-work-equivalent.
III) Machinery/capital efficiency
-Horse power/ha.of land available and used.
Physical efficiency Ratio measures
a) Land use efficiency-measures rate of production.
Total Production
1. Yield per hactare=
Number of Hectares
2. Production efficiency-this is a measure of production efficiency of a farm with
respect to any particular enterprise and can be expressed in terms of percentage as
compared to the average yield of the locality.
Average Yield of the Farm
Production efficiency= ;
Average Yield of the Locality
3. Intensity of cropping- measures the extent of the use of land for cropping purpose
during a given year.
AreaCropped
Intensity of cropping =
Total Cultivated Area
4. Crop yield index- is a measure of comparison of the yields of all crops on a given
farm with the average yields of these crops in the locality.
b) Labor use efficiency
Total Hectare Under Crop
1. Crop hectare per man equivalent=
Man Equivalent
- measures the amount of land under crop per unit of labor.
Man-equivalent: standard measure of labor. Labors standardized into adult man equivalent.
c) Capital efficiency(i.e power, machinery and equipment costs per crop hectare)
 Total Cost
Machinery cost per crop hectare=
Total Crop Hectares
Total Machinery investment
Power and equipment investment per crop hectare=
Total Crop Hectare s
Financial efficiency measures
It may be aggregate or ratio efficiency measure. Balance sheet and income statement can
be used as financial efficiency measures.
Measures of farm income and profit efficiency
1. Net cash income =total cash receipts from production minus total cash operating
expenses.
2. Net farm income=net cash income plus or minus change in inventory in non-
depreciable items and depreciation on power machinery livestock, buildings, etc.
3. Farm earnings=net farm income plus value of farm privileges (farm products) used in
home.
4. Family labor earnings= farm earnings minus interest charges on farm capital
5. Percent returns to capital=ratio of farm earnings minus imputed value of the family
labor to average capital investment, expressed in percent terms.
6. Returns to management=family labor earnings minus imputed value of the family
labor.

Consider the following example.

Particulars and efficiency measures Value(Birr)
1. Cash receipts
Sale of crops---------------------------------------------------- 1700
Sale of milk----------------------------------------------------- 150
Sale of eggs----------------------------------------------------- 100
Other sales ------------------------------------------------------ 150
Subtotal --------------------------------------------------------- 2100
2. Cash expenses
Labor------------------------------------------------------------ 500
Seeds------------------------------------------------------------ 50
 Fertilizer-------------------------------------------------------- 200
Others----------------------------------------------------------- 410
Subtotal--------------------------------------------------------- 1600
3. Change in inventory----------------------------------- 300
4. Farm privileges---------------------------------------- 600
5. Interest charge @8%on average farm capital------ 200
6. Imputed value of family labor----------------------- 450
A. Net cash income (1-2)=940
B. Net farm income(A+3)=1240
C. Family earnings(B+4)=1860
D. Family labor earning(C-5)=1660
E. Returns to management(D-4)=1210