Farms of similar type and size often have observed differences in net farm income. Net income on any farm depends on several factors. Most of the difference in net income between farms can be attributed to farm size, yields, input costs, enterprise (crop) combinations, fixed costs and commodity marketing. A complete analysis of these areas of the farm business should be conducted on a regular basis.
Fixed Costs
The first area to check is fixed costs, such as machinery and building depreciation, interest and general farm overhead costs. If they are high relative to the farm size and value of production, steps should be taken to reduce those which will have little or no effect on the level of production. Reducing fixed costs may be difficult and require some time, but all current and new investments and their related fixed costs should be carefully scrutinized. If the fixed and overhead costs appear satisfactory, check the economic efficiency measures for excessive variable (input) costs.
Economic Efficiency Measures
Some of the more common measures of economic efficiency are fertilizer expense per acre, insecticide expense per acre, herbicide expense per acre, and diesel fuel expense per acre. Any variable cost category you can identify should be examined. A good accounting system could produce any of them with little effort. Converting these costs to a per acre basis can make them comparable to the cost of production estimates published by the Cooperative Extension Service or to other farms similar to yours.
Profitability Analysis and Financial Efficiency
The use of financial ratio analysis is another approach that assists in identifying profitability problems within an operation. Ratios provide a common relationship that simplifies multi-year business analysis. In some instances, ratio analysis allows for balance sheet and income statement information to be combined. This provides insight relating to how the two statements influence one another. To a great extent, net worth value on the balance sheet is directly tied to profitability of the income statement. A business’s net worth and equity increases only if: 1) asset values appreciate or 2) a net profit was produced. When a profit is generated, it shows up on the bottom line of the income statement and most likely in the current assets portion of the balance sheet.
Scott Stiles has worked for the University of Arkansas Cooperative Extension Service for over 11 years.
