Day 1: the accounts

Most farm money talk starts with the accounts. These are the reports your accountant prepares each year. Here are the words you'll meet first.

The two main reports

Profit and loss. This shows the income and costs for a year, and what's left over. It is also called a P&L or an income statement.

Balance sheet. This shows what the business owns and owes on one day, usually 30 June. What it owns are its assets, like land, stock, machinery and cash. What it owes are its liabilities, like loans, the overdraft and bills not yet paid.

Equity is assets less liabilities. It is the part of the business that is truly yours.

Words about income and costs

Budget. A plan for the year's income and costs. It shows whether the year should make a profit. It doesn't show when the money moves. That is the job of the cashflow, in lesson 2.

Variable costs. Costs that go up and down with the size of an enterprise, like feed, drench and freight.

Overheads. Costs that don't change much with the size of an enterprise, like rates, insurance and permanent wages. They are also called fixed costs.

Gross margin. NSW DPI defines it as the gross income from an enterprise less the variable costs of achieving it. It leaves out costs such as depreciation, interest, rates and permanent labour. So it is not profit. It is a way to compare one enterprise with another.

Depreciation. The cost of machinery, buildings and improvements, spread over their working life. It is a cost in the accounts, but no cash leaves the bank for it that year.

Three lines the bank looks at

EBITDA. Earnings before interest, tax, depreciation and amortisation. Amortisation is like depreciation, but for things you can't touch. EBITDA is close to the cash the business earns.

EBIT. Earnings before interest and tax. It is EBITDA less depreciation and amortisation. Banks often start from EBIT to see how well profit covers the interest bill.

Profit before tax. EBIT less interest. Your accountant works out taxable income from this figure, with some adjustments, and tax is based on that.

Where to start

Ask for the last three years of accounts. Read the profit and loss first. Find the income, the biggest costs and the profit line. Then look at the balance sheet and find equity. Don't worry if it takes a few goes. Everyone learns this way.

Keep our farm finance words card handy. The full farm finance glossary has more terms.