The farm financial model is a concept for understanding the financial flow of the farm business. Collecting and organizing financial information (records) through an accounting system is the first step. This financial information is transformed into financial statements for analysis and interpretation of the farm’s historical and current financial position and performance. Budgeting, feasibility, profitability and risk-ability analyses allows the farmer to make the best decisions possible for the farm business’s future.
Organizing the records provides the farmer with the financial information necessary to complete management reports, which are also known as financial statements. The Farm Financial Standards Council (FFSC) recommends farmers create four financial statements from which the financial position and performance may be analyzed. Financial statements should be prepared on a consistent basis. Statements include balance sheet, income statement, statement of cash flows, and statement of owner equity. The income statement, statement of cash flows, and statement of owner equity cover the same time period, and the balance sheet provides values for the beginning and end of that period. The strength of the business at a point in time (position) and how well the farm business has performed over time (performance) are two historical insights reported as financial statements.
- Financial position describes the farm’s assets. Assets include the tangibles needed by the farm business to function, such as cash, machinery and equipment, livestock, and other inventories.
- Financial performance describes how money flows through the farm business and how well the business can pay its bills, meet payroll costs, and how much money is reserved for unanticipated expenses.
- Financial analysis provides an opportunity for the farmer to determine the farm business’s profitability and financial efficiency. Using information generated from the management reports (financial statements), the farmer can benchmark the business against other farms in the industry, determine strengths and weaknesses, measure financial progress, and set financial goals. Financial analysis also allows for future management and decision-making.
Through the second step, the farmer has completed the historical review and understanding of the farm business’s financial position and performance. Financial measures, as absolute measures or financial ratios (Financial Scorecard) can be most informative when analyzed to the same measures in the previous time periods or benchmarked to comparable farm businesses (Benchmarking). This financial analysis provides a basis from which to plan for the future and draft pro-forma financial statements.
Functionally, the farmer wants to understand and make business decisions, considering the feasibility, profitability, and risk-ability of the farm business. The farmer needs to utilize the production and financial information from records and management reports, and transform this information to help analyze decisions. The common tools used include Cash, partial, and enterprise budgets.
Understanding the farm business’s history of financial position and financial performance provides a basis for the farmer to make decisions and plan into the future. Pro forma refers to the future view of the farm’s financial position and performance. For example, what would the balance sheet look like after a future expansion? The future financial position can be analyzed for feasibility, profitability, and risk-ability. Pro forma financial statements complement the farm’s budgets. Cash, partial, and enterprise budgets are commonly used to assist the farmer in decision-making.
The farm financial model helps the farmer make the best decisions for the farm business. From record keeping to financial analysis, this model illustrates how to make sound financial decisions and identifies tools to help in the process.
References: Farm Financial Standards Council. (2021, January). Financial guidelines for agriculture.
This material is based upon work supported by USDA/NIFA under Award Number 2018-70027-28586.
Developing a Farm Financial Model (2021), drafted by Katie Wantoch, UW-Madison Division of Extension; reviewed by Kevin Bernhardt UW Center for Dairy Profitability/UW-Platteville, and Jenny Vanderlin, UW Center for Dairy Profitability; based on material from Understanding the Farm Financial Model factsheet (2018), by Sandy Stuttgen, UW-Madison Division of Extension.