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Financial and Economic Terms Dean Mccorkle and Danny Klinefelter*

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Financial and Economic Terms Dean Mccorkle and Danny Klinefelter* EAG- 035 February 2017 Risk Management Series Financial and Economic Terms Dean McCorkle and Danny Klinefelter* General Accounting and Financing flow budget can be compared to the state- ment Terms of cash flows periodically to determine if, when, and where the actual cash flows vary significantly Generally accepted accounting principles from the budgeted amounts. (GAAP) — Concepts, philosophies and Cash flow statement — a financial statement procedures that guide accounting practices that shows the dollars flowing in and out of the and standards for different industries, but business. The cash flow statement is usually not a precise set of accounting rules. Several divided into operating, investing and financing authoritative organizations and boards of the activities. Cash flows are usually presented by the accounting profession are sources of GAAP, week, month, quarter or year for each income and the most authoritative being the Financial expense category. This statement is particularly Accounting Standards Board (FASB). valuable for analyzing the management of cash in Pro forma statements — a financial statement the business. or presentation of data that represents financial Liquidity — the ability of the business to performance based on projections of events and generate sufficient cash to meet total cash conditions. Examples are a pro forma balance demands without disturbing the on-going sheet and a pro forma income statement. operation of the business. Cash and Cash Flow Terms Net cash flow from operations — the amount Cash — cash and funds in checking accounts, of cash available after cash operating expenses are savings accounts and certificates of deposit. It subtracted from cash operating income. is generated by business sales and other receipts Repayment capacity — measures the ability to minus cash operating expenses, debt payments, repay debt from both farm and non-farm income. capital purchases and family living expenses. It evaluates the capacity of the business to service Cash flow budget — similar to a statement additional debt or to invest in additional capital of cash flows (defined below), but comprised of after meeting all other cash comitments. budgeted dollar amounts rather than the actual dollars flowing in and out of the business. A cash *Extension Economist–Risk Management and Professor and Extension Economist, The Texas A&M System. Income and Income Statement Terms Value of farm production (VFP) — the income from sales plus other receipts, minus the cost Accrual basis of accounting — a method of of items purchased for resale (such as feeder accounting under which revenues are recognized livestock), minus the cost of purchased feed, in the accounting period when earned regardless plus or minus changes in operating inventories. of when cash is received, and expenses are This accrual basis income reflects the value of recognized in the accounting period when production whether sold or not. incurred regardless of when cash is paid. Expense or Cost Values Cash basis of accounting — a method of accounting under which revenues are recorded Various expense or cost values are used in when cash is received and expenses are recog- economics and accounting. The definition, and nized when cash is paid. thus derivation, will depend on the financial statement being developed and in what context Income statement (or profit and loss the business is being analyzed. Some important statement) — a summary of accrual adjusted expense or cost values are: revenues and expenses for a specific time period Variable costs such as an operating or accounting year. The — expenses that vary with output income statement is useful in analyzing the for the production period under consideration. financial performance or profitability of the Seed, fuel, feed and fertilizer are examples of business. An income statement can also be variable costs. developed for a specific enterprise. Fixed costs — expenses of an “overhead” nature Profitability — the ability of the business that do not vary with changes in output for the to generate income in excess of expenses. production period under consideration. Real Profitability can be analyzed using the income estate taxes, depreciation and interest on land are statement and balance sheet. (NOTE: For specific examples of fixed costs. measures of profitability, please refer to L-5275, Cash costs — costs that result in an actual “Income Statement – A Financial Management payment of cash. Example of cash costs include Tool.”) seed, fertilizer, labor and fuel. Gross Income Values Non-cash costs —costs that do not result in There are different measures of gross income an actual payment of cash. Examples include or receipts from a business. Three important depreciation, the change in prepaid expenses, measures are: changes in inventory, and accrued taxes. Gross farm income (GFI) — the income from Direct expenses — expenses such as fertilizer sales plus other receipts, minus the cost of items and seed that are directly related to a production purchased for resale (such as feeder livestock), activity. plus or minus changes in operating inventories. Indirect expenses — expenses such as real This accrual basis income reflects the value of estate taxes that are not directly related to a production whether sold or not. production activity. Gross revenue (GR) — the income from sales Accrual farm expense — the amount of plus other receipts, plus or minus changes in expense, even if not paid, that is associated with operating inventories. This accrual basis income production for the operating or calendar year. reflects the value of production whether sold or not. Depreciation — the allocation of the original cost of a capital asset over the useful life of the asset. 2 Financial costs — all expenses in the accrual Net Income and Return Values adjusted income statements. Expenses include The income statement, which provides a cash costs, depreciation, and non-cash summary of accrual adjusted gross revenue and adjustments such as accounts payable and expenses, in conjunction with the balance sheet, accrued interest. allows one to derive various net income and Prepaid expenses — expenditures made in the return values, such as: current operating or accounting period that will Net farm income from operations — equal to be used in a future period to realize rev- enue. gross farm income (GFI) minus total expenses (GFI), or gross revenue (GR) minus total expenses Total costs — the sum of fixed and variable (GR), or value of farm production (VFP) minus costs. total expenses (VFP). The method of calculating total operating expenses or total expenses depends on what you Net farm income — equal to net farm income are trying to analyze and which gross income from operations plus the gain (or loss) from the valuation method you use (GFI, GR or VFP). The sale of capital assets and the change in base values following are three common methods of expense of breeding livestock. Net farm income is accrual determination: adjusted and represents a return to operator’s labor, management and equity capital. Total operating expenses (GFI) — the sum of cash and non-cash expenses plus or minus the Net profit margin — shows the portion of gross associated accrual and expense inventory adjust- revenue that the business receives as profit. ments. It includes the cost of purchased feed, but does not include the purchase of items for resale Return to capital — a measure of the operator’s or interest expense. capital earnings from the business. It is equal to net farm income, plus interest expense, minus a Total operating expenses (GR) — the sum charge for the operator’s labor and management. of cash and non-cash expenses plus or minus the associated accrual and expense inventory Return to management — a measure of adjustments. It includes the cost of purchased the operator’s management earnings from the feed and purchases of items for resale, but does business. It is equal to net farm income, minus a not include interest expense. charge for the operator’s labor and equity capital. Total operating expenses (VFP) — the sum Return to labor and management — of cash and non-cash expenses plus or minus a measure of the earnings to labor and the associated accrual and expense inventory management from the business. It is equal to net adjustments. It does not include the cost of farm income, plus hired labor expense, minus a purchased feed, purchases of items for resale, or charge for the operator’s equity capital. interest expense. Return to capital, labor and Total expenses (GFI) — equal to total operating management — a measure of the earnings to expenses (GFI) plus interest expense. capital, labor and management from the business. It is equal to net farm income, plus hired labor Total expenses (GR) — equal to total operating expense, plus interest expense. expenses (GR) plus interest expense. Total expenses (VFP) — equal to total operating expenses (VFP) plus interest expense. 3 Assets, Liabilities and Balance Sheet to withstand risks and continue operations after Terms financial adversity. Accumulated depreciation — the amount Balance Sheet Assets of depreciation expense taken on machinery, The asset side of the balance sheet will include equipment and building assets from their the following types of values: acquisition date to the date of the balance sheet. Assets — resources owned by or owed to the Average owner equity — the average of the business such as livestock, equipment, real estate beginning and ending owner equity for an and notes
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