RESPONSABILIDAD DE LA DIRECCIÓN 1 Compromiso de la alta dirección

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6.0 TUTOR-MARKED ASSIGNMENT

1. Define the following terms:

i. Assets ii. Liabilities

iii. Net worth iv. Net capital ratio v. Equity value ratio vi. Current liability ratio.

2. What does each of the above three ratios indicate?

3. What precautions will you take in preparing the balance sheet of a business farm?

7.0 REFERENCES/FURTHER READING

Nelson, A. G. & Murray, W. G. (1968). Agricultural Finance. USA:

Iowa State University Press.

Olukosi, J. O. & Alamu, J. F. (2013). Introduction to Agricultural Finance: Principles and Applications. Nigeria: Great Glory Publishers.

Reddy, S. S. & Ram, P. R. (2004). Agricultural Finance and Management, New Delhi: Oxford & IBH Publishing Co. PVT.

UNIT 8 INCOME STATEMENT

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4.0 Conclusion 5.0 Summary

6.0 Tutor-Marked Assignment 7.0 References/Further Reading

1.0 INTRODUCTION

In the last unit you learnt about the net worth statement. The other side of the coin in farm planning is the net income statement. This unit focuses attention on the net income statement.

2.0 OBJECTIVES

At the end of this unit, you should be able to:

 determine net farm income

 determine financial test ratios and what they mean to the farmer

 determine management ratios.

3.0 MAIN CONTENT

3.1 Income Statement or Profit and Loss Statement

This is entirely different from a balance sheet in the sense that in a balance sheet, we consider assets and liabilities and did not consider operational efficiency in terms of receipts and expenses. In income statement the items included are receipts, expenses, gains and losses. It could be defined as a summary of receipts and gains minus expenses and losses during a specified period. It is prepared for the entire farm for one agricultural year. In income statement monetary values are assigned to inputs and output. It is also prepared over time. The advantages of this statement are that it indicates the trend in various cost items and whether there has been any over expenditure on the farm. Thus, it helps to know the success or failure of a business farm over time. Income statement basically constitutes three items, viz., receipts, expenses and net income. Income statement of a hypothetical farm is presented in Table 21.

Receipts: They mean the returns obtained from the sale of crops produce and other supplementary products like milk and eggs, wages, gifts, etc.

Gain in the form of appreciation in the value of assets is also included in the receipts. However, returns from the sale of capital assets, such as livestock, machinery, farm buildings, etc. are not included because such returns/income are not really obtained during the period.

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Expenses: Operating and fixed costs are recorded here. Losses in the form of depreciation on the asset value fall under the expenditure item.

However, the amounts incurred on the purchase of capital assets are not considered.

Net income: It constitutes net cash income, net operating income and net farm income.

Net cash income: It gives the position of cash receipts minus cash expenses only during the period for which income statement is prepared.

Net operating income: It is arrived at by deducting operating expenses from the gross income. Fixed costs are not given any consideration.

Operating expenses include crop loans.

Net farm income: Net farm income equals net operating income less fixed costs. Compared to net cash income and net operating income, it is relatively a better measure of assessing the performance of a farm. It is the return which accrued to owned capital and family labour employed.

Income statement prepared for a given farm for a given year may present a very bright picture of the farm. The same position cannot be taken for granted as the actual position of the farm, since the said year might have been a good agricultural year with respect to weather, yields, prices, etc. A realistic position on the performance of a farm can be gauged by preparing income statements over years to show the actual situation, as the parameters influencing farm business are subject to fluctuations.

3.2 Financial Test Ratios

The performance of farm business as indicated in Table 21 can be assessed through the income analysis by gainfully using two important parameters, viz., costs and returns. Still, some additional information is left untouched if we do not regard financial test ratios, as they supplement new information. These help the farmers themselves as well as lending institutions, and help in developing standard norms. Two sets of income ratios can be developed. One is directly from the income and expenditure pattern, and another by taking one component from income statement i.e., income levels and comparing against capital investment made on the farm business. The former ratios are called expenses-income ratios and the latter, investment-expenses-income ratios.

Table 21: Income Statement of a Hypothetical Farm

Particulars Amount

(in N) I. Receipts

A. Returns from the sale of crop output (paddy + pulses) B. Revenue from milk and milk products

52,000 5,000

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Returns from poultry enterprises 12,000

Returns from supplementary enterprises 17,000

C. Gifts

D. Gross cash income

E. Appreciation on the value of assets F. Gross income

2,000 7,000 3,000 74,000 II. Expenses

Operating expenses or costs A. Hired human labour B. Bullock labour C. Machine labour

D. Seeds

E. Feeds

F. Manures and fertilisers G. Plant protection measures H. Veterinary aid

I. Irrigation J. Miscellaneous

K. Interest on working capital

10,500 900 1,500 1,100 5,000 3,000 1,550 500 250 2,000 2,100

Total operating expenses 28,400

Fixed expenses or costs A. Depreciation B. Land revenue

C. Interest on fixed capital (includes interest of N1500 paid towards term loan)

D. Rental value of owed land Total fixed costs

3,000 200 3,200 10,000 16,400 III. Net cash income 71,000 – 28,400 = 42,600

IV. Net operating income 74,000 – 28,400 = 45,600 V. Net farm income 45,600 – 16,400 = 29,200

Following are the ratios which can be obtained directly from the income statement.

Total operating expenses Operating ratio =

Gross income = 28,400 = 0.38 74,000

As the very name reveals, the ratio explains the relationship of operating costs to gross income. This ratio underlines the magnitude of working expenditure incurred for each naira of gross income. This is a direct ratio which works out to 0.38.

Fixed expenses Fixed ratio =

Gross income = 16,400 = 0.22

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74,000

This ratio indicates the relationship between fixed expenses and gross income. This particular ratio is 0.22. It depicts the amount of fixed expenses incurred to realise a naira of gross income. This is an indirect ratio, since fixed costs are indirect costs.

Total expenses Gross ratio =

Gross income = 44,800 = 0.61 74,000

This is the ratio which is obtained when both operating expenses and fixed expenses are totaled up and compared with gross income. This can be called input-output ratio, which amounted to 0.61. All these ratios should be less than one to indicate the profitable run of the farm business. When these ratios are estimated over a period of time, a healthy trend of farm business is reflected by the descending ratios.

Investment-Income Ratios: Following two are the ratios which fall under this category.

Gross income Capital turnover ratio =

Average capital investment = 74,000 = 0.25 300,000

This is also a self-explanatory ratio as explained earlier. Here, average capital investment is arrived at by adding the value of assets at the beginning of the agricultural year and at the end of the agricultural year and then averaging the two values. Suppose it is N300, 000, then the capital turnover ratio is 0.25. This ratio gives the gross income obtained for each naira of capital invested over the year.

Net return to capital Rate of return on investment =

Average capital investment = 27,800 = 0.09

300,000

Net return to capital is obtained by adding bank interest paid (interest on borrowed funds + interest paid on term loans) to the net livestock operations and management.

Net farm income (in N) = 29,200 Interest paid during the year (in N) = +3,600