Traditionally, many farms used their accounting software as not much more than a check register to compile cash tax information for their tax accountant. Accounting software should be able to produce information that gives dairy farm management valuable analysis on the profitability of different areas of their business, calculation of cost of production, evaluation of financial health (financial ratios) and other management information.
One of the weaknesses of a cash-only accounting system is that it often splits the costs of production across multiple calendar years and has difficulty in tying revenue to the specific costs associated with the production of those goods sold. It also leaves your company with a balance sheet that is mostly useless for calculating any financial ratios.
The next stage of accounting systems will allow for accrual adjustments to be made to the balance sheet. Those adjustments are usually only done once a year. With those accrual adjustments, certain ratios can be calculated on the company to assess its financial health. However, very often the accrual adjustments made to raised inventories, such as replacement animals, are done only once a year, and inventory is often valued at market value because of the difficulty in determining the true cost of the inventory.
In order to have financial records that can help make solid financial decisions, it would be best to use an accounting system that allows for true accrual accounting. For raised inventories, the value of the inventory is usually built on the balance sheet. The costs involved with producing that inventory are represented on the balance sheet, and in the final stage of production those costs are moved into the value of the finished goods inventory. This makes it much more possible to match the sale of inventory with the costs to produce it when it is sold. Knowing what the inventory costs to produce helps to make better decisions.
Choosing the correct accounting method is only one part of the equation. It still limits some of the ways management can analyze the profitability of the different areas of their business. If your accounting system allows you to mix production information with your accounting records, it can expand the information available to management to make important decisions on the farm. Sometimes a farm engages in certain activities or produces certain items for which they don’t know whether they are profitable or not because the costs are rolled up with costs from other areas of their business.
Having attributes you can attach to both revenue and expense transactions that tell the system which crops they are for, what field it was associated with and what production year should be credited allows you to look at your financial records in multiple ways. With that information, an accounting system could allow you to produce reports that indicate whether it was profitable to produce a certain variety of a crop in a production year. You should be able to tell whether the amount of rent a landlord wants to charge will allow you to make any money on a field. That same concept can be applied to livestock operations and dairy operations.
Knowing your total cost to produce inventory is valuable, but by adding the ability to also track units of measure for your inventory, you can now evaluate things like what was the cost per bushel to produce a product like corn or what was the cost per head or per hundredweight of milk. Also, if you now can evaluate things like feed costs per cow or fertilizer cost per acre on a field, it arms management with the ability to benchmark your company against other similar organizations, and it can be valuable information for predicting future costs.
As an example, if you can look at several production periods of milk on a dairy farm, you can spot trends like the gradual trending increase in the cost of a nutrient used for milk production per cow. If management knows a nutrient that is necessary for their milk production is going to continue to gradually increase in price, they can either adjust their budgets to reflect that trend or they can start exploring possible alternatives.
Beyond production information, some accounting systems allow you the flexibility of integrating other performance measures. For example, in a dairy, you might want to be able to look at what the breakeven point of production is per milking cow over several production periods. The financial information is already in your accounting system, but being able to track the number of milking cows versus total cows and use those in analysis is what will allow for powerful management reporting.
On top of production details, it might be beneficial to explore an accounting system that allows for tracking other management details you can use flexibly to meet your company’s needs. An example of a management detail like this is the use of projects.
A project can be virtually anything you want it to be. If you can identify what expenses or revenue are associated with a specific project or activity, you can get reporting on that project. For example, if a farm wants to try and identify all of the costs associated with harvesting their crops, they could set up a project of harvesting and not only identify those costs with a specific crop, but they can also associate that cost with the activity or project of harvesting. Another type of management detail that could fit into this same example is identifying their harvesting activity with the specific piece of equipment used.
Having an accounting system with enough flexibility to answer your management reporting needs should be the goal to save time and reduce making decisions on incorrect or incomplete information. 
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Julie Strain
- Ag Financial Accounting Expert
- Red Wing Software
- Email Julie Strain
