Use an income statement to determine profits
The Income State provides a business with valuable information … How much money did we make?
The main purpose of the income statement is to measure the profitability of a farm or business and to answer the age old question, “how much money or progress financially did we make?” The income statement provides a farm or business the information on how the farm got to this point over a period of time.
In simplest form, the income statement shows all of your income and all of your expenses from production that is reflected in the inventories and the financial reflected in the cash transactions. At the bottom of the income statement a “Gross” income value is placed and the same is also true for expenses. Usually the last number shown on the income statement is the Net Farm Income.
Gross Income - Gross Expense = Net Farm Income.
There are three types of income statements; 1) A Cash income statement; 2) An accrual income statement; and 3) Accrual adjusted income statement.
- A cash income statement is usually what is used on the IRS tax
Schedule F. This is helpful for doing taxes but it does not appropriately
measure the profitability of the farm.
- A true accrual income statement can
easily be developed if a farm or business is using an accrual accounting system that posts income and expenses when they
are accrued, not when a check is actually received or written like it is in a
cash accounting system. Since most farms use a cash accounting system that is
allowed by the IRS an Accrual adjusted income statement is created and used.
- An accrual adjusted income statement will use the years beginning
balance sheet (or the previous years ending balance sheet) and a year-end
balance sheet to adjust the cash accounts for the changes in inventory for the
year and is added/subtracted from the Cash Income. Depreciation is subtracted
from the Cash Income to create the Net Cash Income for the year.
This sample accrual adjusted income statement which is the recommend for most farm businesses to use if they what to monitor the financial progress of their farming enterprises.
Many people ask why is it necessary to have a balance sheet and an income statement. The Balance sheet helps a farm or business measure the financial position of the business. The balance sheet is snap shot in time it shows where we are “now” but not what caused the business to get to that point.
For further information or questions please feel free to contact Adam Kantrovich, MSU Extension farm management educator.