Balance sheets and income statements: Farm financials you need to know
Gearing up for another year? FCC Ag Economics wants to pump up your farm financial fitness. Throughout March, we'll be sharing posts to help put your 2017 farm financials into a larger context. We'll also makes sense of key financial tools as you go. Check back weekly to see where Canadian ag is going and how you can stay ahead.
In this post, we’ll look at what’s ahead in 2017 and dive into the difference between your farm income statements and balance sheets. They’re basic financial tools, but important to master because they drive your business decisions.
The farm economy slowed in 2016: what’s ahead?
In 2016, both commodity prices and farm input prices declined because supply climbed faster than demand in global markets. Those price declines and their impacts to revenues, expenses and profitability are reflected in Agriculture and Agri-Food Canada (AAFC)’s 2017 Canadian agricultural outlook.
AAFC estimates Canadian farm cash receipts to have totalled CA$59.1 billion in 2016, a 1% decline from 2015 revenues. Total farm operating expenses in 2016 are estimated to have been CA$44.2 billion. The sector’s total net realized income (revenues – operating expenses and depreciation) was CA$7.7 billion in 2016, or 7% below the record-high profitability of CA$8.3 billion reached in 2015.
AAFC projects Canadian agriculture will see stable revenues overall in 2017, with a decrease of less than 0.5% over the estimated 2016 level. Driving those revenues will be continued strength in global demand for Canadian exports and continued weakness in the Canadian dollar, expected to remain throughout 2017 at about US$0.75. AAFC projects total operating expenses at CA$45.0 billion in 2017. They’re not likely to increase too quickly, as oil prices are expected to remain at roughly US$50/barrel in 2017 and despite supply limitations for key fertilizers.
Stable farm revenues and small increases to expenses yield a bottom line that is roughly equal to the 5-year average. Projections of the Canadian agriculture sector’s year-over-year profitability of CA$6.7 billion in 2017 as measured by total realized net income.
What this means for you
Overall, Canadian agriculture’s total net income is projected to hold up in the face of some pressure throughout 2017. For a deeper dive, take a look at our Outlook for your individual sector.
Knowing this can help anticipate changes you could see in your income statement in 2017. It can also identify efficiency gains needed to face revenues levelling out in 2017.
Understanding your farm income statement
The income statement summarizes business operations as the revenues and expenses during a given time period resulting in a profit or a loss. It’s dynamic in nature.
How does it work?
A livestock producer records her sales, the changes in inventory values and the sale of capital assets as revenues. She records cash expenses such as wages, feed, insurance and interest as expenses. Other non-cash expenses include the depreciation of capital assets such as breeding livestock.
Managers rely on the income statement to review their operational efficiency and make changes as needed (e.g., reducing costs). They assess how much the company earns now, and in relation to its recent history. Comparing your individual income statement to expected profitability of overall agriculture allows you to identify potential challenges faced by partners in your value chain.
Expanding? The income statement will reveal if you are growing your bottom line and production simultaneously. Showing a net profit on the income statement supports your position when discussing your future strategy with key stakeholders and financial advisors.
Overall asset values, debt expected to increase in 2017
Land typically accounts for a majority of all farm assets. That was true in 2015 (see our 2015 Farmland Values Report), when land values totalled two-thirds of Canadian farm asset values. Our analysis suggests that the value of land and buildings climbed around 4% in 2016. This continued land values’ upward trend, albeit at a slower pace than in previous years. We project it to increase between 1% and 3% in 2017. Farm cash receipts, once again higher than the five-year average, are expected to drive these land value increases.
That anticipated growth in farm asset values in 2016 and 2017 helped push FCC’s debt projections of September 2016 slightly upward for both years. We expect soon-to-be-released data will show farm debt outstanding grew around 7% in 2016 and that it will grow further in 2017, between 3% and 5%.
Debt likely grew faster than asset values in 2016 – and it should continue to do so in 2017. However, net worth (owners’ equity, or assets - liabilities) across Canadian agriculture as a whole is still expected to climb. AAFC estimates a 4% increase in both 2016 and 2017. That’s generally good news and speaks to the sector’s resiliency and optimism. Canadian farm equity has continued to grow despite softer commodity prices, thanks in part to the buffering effect of the dollar on overall revenues.
I say this with one caution: The lower total net income expected across Canadian agriculture in 2017, combined with the overall sector’s growing equity, suggests we’ll see a lower rate of return on equity in 2017. This isn’t necessarily reason for concern as the current environment of low interest rates helps, but it’s certainly one element to keep monitoring.
Why? Financial risk is incurred by borrowing money. Businesses should be earning a higher rate of return on equity than the rate they pay on debt.
Understanding your farm balance sheet
The balance sheet details the assets (what a business owns), liabilities (what it owes) and owners’ equity (the value of investments made). It’s a snapshot – a single moment in time – detailing the financial health of the business.
How does it work?
An operation’s assets include:
- Current assets: the cash, prepaid products or services (e.g., taxes, rent), accounts receivables (money owed to the operation), and inventories (commodities for future sale or goods used to produce commodities) available to be converted to cash during one normal operating cycle (usually 1 year)
- Fixed assets: the resources needed to sustain long-term business activities, including buildings, land and equipment
An operation’s liabilities include:
- Current liabilities: the amount for inventory, supplies or equipment purchased on credit and to be paid in the upcoming operating cycle
- Long-term liabilities: mortgages and long-term loans from financial institutions or others.
Owner’s equity/ net worth: the value of investments made in the business.
A manager uses the balance sheet, in combination with the income statement, to determine four components of financial performance:
- Profitability (measures the ability to generate a return on equity)
- Liquidity (measures the ability to meet current financial commitments)
- Solvency (measures the ability to repay long-term debt), and
- Efficiency (measures the competitiveness of an operation)