Today’s producers have access to more data than ever, yet it remains a challenge to turn it into meaningful information to support better decisions.
Producers want to know their true, all-in cost of production and breakeven price for specific acres or herds. They want to better forecast their cash flow and working capital needs. And they want to know whether major investments are likely to pay off.
Accrual-based managerial accounting offers a solution for those who want a deeper understanding of their operation and the financial insights that can help it grow.
A better picture
Many producers’ tax records follow a cash-based accounting method that looks at all the cash transactions in a single tax year. Those records are relatively simple to maintain. In addition, many small businesses, including farmers and ranchers, find that cash-based accounting offers tax advantages.
Accrual-based reports provide a more complete picture of how individual production units perform across a multi-year period. These reports hold all expenses related to a single crop or livestock herd in dedicated accounts – that is, they “accrue” those expenses. In that way, accrual records keep an ongoing tally of profit or loss in real-time until a sale is made and net income is realized.
Two ways of looking at the same data
In the example below, cash-based accounting shows a net loss of $40,000 in Year 2, while accrual-based managerial analysis shows that your Year 2 crop earned $120,000.
Cash-based accounting looks at all the cash inflows and outflows in a single year – that’s like totaling the income and expenses, top-to-bottom, in each column of this table.
Accrual-based accounting uses the same underlying information but looks at all the income and expenses associated with a single crop (or herd of livestock or flock of poultry). That’s like totaling the income and expenses, left to right, in each row of this table.
Accrual accounting provides a better picture of how each crop performed financially because it matches the true costs of producing that crop with the actual revenue received from selling the production.
Three branches of accounting
There are many ways to use accounting information, and accountants often categorize those uses into three branches.
Managerial accounting provides the most useful information for making decisions about the ongoing operation of a farm or ranch. It organizes transactions in ways that give a complete picture of how various production units are performing. That allows producers to evaluate past decisions and analyze the potential impact of future decisions. One of the most powerful outputs of managerial accounting for agricultural producers is a true breakeven price for each unit of production.
The purpose of financial accounting is to accurately value the farm or ranch business, including all its assets and liabilities. Lenders often study financial accounting reports when making decisions about renewing lines of credit or issuing new loans. Financial accounting information is also useful for succession planning.
Tax accounting is all about compliance. It aims to organize information according to strict IRS and state tax rules. Tax accounting reports usually aren’t very useful for making management decisions about the operation of a farm or ranch.
All three types of accounting use the same set of transactions, each organized differently, to answer different questions.