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Agricultural Marketing Resource Center

Farm Analysis Terms

 

Don Hofstrand  Don Hofstrand                                                        Revised November 2005
 Co-Director, Ag Marketing Resource Center
 Iowa State University Extension
 dhof@iastate.edu

Accounting - A comprehensive system for recording and summarizing business transactions.

  • Accrual accounting - An accounting system that recognizes income when it is earned and expenses when they are incurred, rather than when they are received or paid.
  • Account payable - An expense that has been incurred but not yet paid.
  • Account receivable - The income has been earned but the payment has not yet been received.
  • Accrued expense - An expense that has been incurred, sometimes accumulating over time, but has not been paid.
  • Book value - The original cost of an asset minus the depreciation expense taken to date.
  • Cash accounting - An accounting system that recognizes income when it is actually received as cash and expenses when they are actually paid rather than when they are earned or incurred.
  • Depreciation - An annual non cash expense to recognize the amount by which an asset loses value due to use, age, and obsolescence.
  • Double entry accounting - An accounting system in which changes in assets and liabilities as well as income and expenses are recorded.
  • Inventory - A complete listing of the number, type, and value of assets owned at a point in time (e.g. January 1.)
  • Single entry accounting - An accounting system where income and expenses are recorded, changes in assets and liabilities are not.
  • Prepaid expense - A payment made for an input or service prior to the accounting period in which it will be used.
  • Salvage value - The market value of a depreciable asset the time it is sold or removed.

Appreciation - The increase in the value of an asset due to varying economic or inflationary conditions.

 

Breakeven price - The price a producer must receive for a product in order to recover all of the costs associated with producing the product.

  • Accounting cost breakeven - The price needed to recover the explicit costs associated with producing the product.
  • Cash flow breakeven - The price needed to recover the cash expenditures associated with producing the product.
  • Economic cost breakeven - The price needed to recover the explicit and implicit costs associated with producing the product.

Budgets - A written plan or estimate of future income and expenses of an activity covering a definite time period.

  • Capital budget - Provides an estimate of the feasibility of making investments in long-term assets.
  • Cash flow budget - see cash flow.
  • Enterprise budget — Provides a listing of all income and expenses associated with a particular enterprise. It is used to estimate the profitability of the enterprise, to compare the profitability of various enterprises on the farm, and as an aid in preparing whole farm or cash flow budgets.
  • Partial budget - Used to calculate the effect on profits of a proposed change in a portion of the operation. It includes only the costs and returns that change as a result of the proposed change in the operation. Because only a portion of the costs and returns are included, the partial budget only provides an estimate of the profitability of an alternative relative to current operations. It does not provide an estimate of the absolute profitability.
  • Planning period - The time period over which the budget is relevant (e.g. one year, one production period, several years, etc.
  • Unit budget - An estimate of income and expenses for one unit of an enterprise (e.g. per acre or per head budgets.)
  • Whole farm budget - A projection of the total production, income, and expenses of a farm business for a whole farm plan.

Capital budgeting - A process for determining the profitability of a capital investment.

  • Annuity - A series of equal cash flows occurring for a specific time period with payments made at the end of each period. Also called annuity in arrears.
  • Annuity due - An annuity with payments made at the beginning of each period. Also called advance payment annuity.
  • Capitalize - To convert future income to current value.
  • Compounding - Determining the future value of a current amount, in which the interest remains with the principal and becomes part of the principal for computing interest in the next period.
  • Discounting - The reverse of compounding. Finding the present value of a future value by deducting the interest.
  • Discount rate - The interest rate used to find the present value of an amount to be paid or received in the future.
  • Discounted cash flows - The present value of a series of future cash flows.
  • Internal rate of return (IRR) - The discount or interest rate at which the net present value of an investment is equal to zero.
  • Net present value (NPV) - The present value of a series of future net cash flows that will result from an investment, minus the amount of the original investment.
  • Opportunity cost of capital - The relevant interest or discount rate used for financial decision making. It is the rate of return that could be earned by investing in the next best alternative.
  • Perpetuity - An annuity that continues forever.
  • Present value (PV) - The current value of one or more payments to be received or paid in the future.
  • Time value of money - The difference in the value of cash received (expended) now versus its value if received sometime in the future.

Cash flow - Cash money flowing in and out of the business. Cash flow is not the same as profitability.

  • Cash flow budget - A summary of all projected cash income and expenditures for a given period of time, normally one year. The budget only includes cash transactions. It shows when additional funds will need to be borrowed and when funds will be available for repayment.
  • Cash inflow - Cash flowing into the business from all sources over a period of time. Includes the sale of farm products, new loans received, sale of capital assets, and nonfarm income.
  • Cash outflow - Cash flowing out of the business from all sources over a period of time. Includes the purchase of production inputs, machinery, repayment of borrowed money, etc.
  • Net cash flow - The difference between (surplus or deficit) over a period of time.

Comparative analysis - The comparison of the performance level of a farm business to the performance level of other similar farms in the same area or to other established standards.

 

Costs - Agricultural costs are often divided into various categories. Some of the more commonly used cost concepts are as follows.

  • Cash costs - Costs that require an outlay of cash during the planning period.
  • Direct costs - Costs that specifically identify with a particular enterprise of the farm. For example, the cost of seed corn is specifically identified with the corn enterprise.
  • Explicit costs - Costs paid outside the business. For example, the payment to the input supplier for commercial fertilizer.
  • Fixed costs - Costs that do not change with the level of production. For example, the cost of owning a hog building is incurred regardless of whether the building is empty, half full of hogs, or overflowing with hogs.
  • Implicit costs - Costs paid within the business (opportunity costs.) For example, a labor charge for operator labor.
  • Indirect costs - Joint costs that do not relate to one specific enterprise but two or more. For example, the cost of a combine is a cost of both corn and soybean production.
  • Marginal costs - The change in cost that results from producing one more unit of production. For example, the cost of producing one more hog. Only variable costs are marginal. Fixed costs are incurred regardless of whether one more unit is produced or not.
  • Mixed costs - Cost that have both fixed and variable components.
  • Non-cash costs - Costs that do not require an outlay of funds during the planning period (either opportunity costs or costs requiring an outlay of funds outside of the planning period). For example, depreciation is a non-cash cost.
  • Opportunity costs - The cost of using a resource based on what it could have earned if used for the next best alternative. For example, the opportunity cost of farming your own land is the amount you could have received by renting it to someone else.
  • Operating costs - Costs for the purchase of inputs and services that are used up in one production cycle (e.g. seed and nitrogen fertilizer). Includes variable costs with a planning horizon of one production period.
  • Ownership costs - These include depreciation, insurance, interest, taxes (if applicable) on buildings, equipment and machinery.
  • Overhead costs - Costs that are not directly related directly to the type and quantity of products produced. A type of fixed cost.
  • Sunk costs - Costs already incurred (fixed costs). For example, when a tractor is purchased it becomes a sunk cost.
  • Variable cost - Costs that change in direct proportion to changes in volume. Variable costs can be avoided by not producing. For example, the cost of feed to feed a steer to a heavier weight is a variable cost. If the steer is not purchased, no feed cost in incurred, but the fixed cost of the livestock building is still incurred.

Input - A resource used in the production of an output.

 

Net farm income - The difference between total revenue and total expenses, including gain or loss on the sale of capital assets. Also called the return to owner equity, unpaid labor, and management.

  • Gross income (revenue) - The total income, both cash and non cash, received from an enterprise or business, before any expenses are paid.
  • Gross margin - The difference between gross income and variable costs. Also called income above variable costs.
  • Net farm income from operations - The difference between total revenue and total expenses, not including gain or loss on the sale of certain capital assets.
  • Value of farm production - The market value of all crops and livestock and other income generated by a farm business as measured by accrual accounting, after subtracting the value of purchased livestock and feed.

Profit - Gross income less expenses.

  • Accounting profit - The value that remains after all expenses except opportunity costs, have been subtracted from gross income. Same as net farm income.
  • Economic profit - The value that remains after all costs, including the opportunity costs of the operator’s labor and capital, have been subtracted from gross income. Same as the return to management.

Net return - Gross income less certain expenses. Often the net return from using a specific resource.

  • Return on assets (ROA) - The value represented by net farm income from operations, plus interest expense, minus the opportunity cost of operator labor and management. Expressed as a percentage by dividing this value by the value of total assets.
  • Return on equity (ROE) - The value represented by net farm income from operations minus the opportunity cost of operator labor and management. Expressed as a percentage by dividing this value by the value of owner’s equity.
  • Return to management - The net return generated by a business after all expenses have been paid and the opportunity costs for owner’s equity and unpaid labor have been subtracted.
  • Return to unpaid labor and management - The net return generated by a business after all expenses have been deducted and the opportunity cost of owner’s equity (but not unpaid operator's labor) has been subtracted.

Payback period - The length of time (i.e. number of years) it takes for the accumulated net returns earned from an investment to equal the original investment. For example, a $1,000 investment that returns $200 per year has a payback period of 5 years.

 

Risk management - The use of various management practices to reduce the production and financial risk of the business. Commonly used practices include diversification, purchasing insurance, hedging or forward contracting, maintaining cash reserves and maintaining flexibility in the operation.

 

Sensitivity analysis - A procedure for assessing the riskiness of a decision by using several possible price and/or production outcomes to budget the results and compare them.

 

Sinking fund - Money set aside and kept separate from other assets in a special fund. A sinking fund may be established to finance the anticipated future purchase of capital assets (e.g. combine.)

 

Trend analysis - Comparison of the performance level of a farm business to its past performance.

 

Whole farm plan - A summary of the intended kinds and sizes of enterprises to be carried out by a farm business.

 

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