AP - The Six Numbers That Show If You’re Making A Profit; Or Why We Need To Be Grateful To Ken Lay

All farm firms, big or small, must manage four different and often intertwined conflicting parts. These are production, marketing, human relations and finance. It’s probably fair to say that in most farms, production is the fun part and finance is the stuff that’s left to bookkeepers. This is unfortunate because the financial part of the farm plays a larger role in firm success than ever before. This is largely due to the increasing importance of timeliness in the decision making stemming from the farm’s financial performance in an increasingly competitive environment, both domestically and overseas. It is also sad, but typical, that the essential financial numbers tend to arrive back from accountants long after the owners should have acted on them. The main reason on many farms is that accountants tend to concentrate on taxes, while owners should focus on financial management decisions, which usually require different numbers. This paper attempts to clarify the mystery of, and ignorance about, all those essential financial statements, by selecting six simple financial management numbers that are timely, that owners can follow easily and therefore improve both their farm decision making and their competitive advantage. The numbers are subjectively ranked in the authors’ views of their importance. These ranked numbers are 1. the firm’s cash and its availability. Cash pays the bills and is the fuel that drives the farm’s finances. 2. net income and how it is used. Net income, or profit, pays for new farm investment, retires principal and provides salaries to the farm’s owners. 3. earnings before interest and taxes, otherwise known as EBIT. This indicates whether the farmer should reduce debt now and therefore lower future interest payments, or invest in a depreciable asset to reduce taxes, or simply accept the number. 4. leverage, which helps in debt management, and shows how much debt the farm owes for every $1 that it owns. 5. the farm’s main cash costs. There are rarely more than five major expenditures on any farm, and these account for at least 75% of the farm’s cash costs, and therefore perhaps 60% of the farm’s total costs. 6. sales, rather than total revenue. Sales provide cash and total revenue may, and often, does not. The paper emphasizes the simplicity of firstly finding these numbers and secondly, using them as trends for decisions. It illustrates the types of decisions in each of the six categories and shows their importance in subsequent firm management.