Last month, I summarized how some ranchers are being let down by their on-ranch accounting systems. This month, I'll focus on “good accounting” and how ranchers can generate good business signals from their beef cow herd's business records. Hopefully, good business signals will lead to better business management decisions.

The first accounting principle to master is that accounting for business profitability, and accounting for family/business cash flow, are two different systems. Each is designed to answer a different set of management questions.

Most on-ranch accounting systems I've reviewed are executed to meet IRS Cash Income Tax reporting needs; managerial accounting is never considered. Similarly, the commercial accounting systems I've reviewed also are directed primarily toward IRS Cash Income Tax reporting. Very few report any managerial accounting data back to ranchers.

This month's column will deal with the topic in simple and general terms; future columns will focus on the details. Let's begin with an understanding of the basic business analysis concepts.

Three questions:

• The first question a rancher should ask his accounting system is: “What did my family earn this last year from running this ranch?”

• The second question is: “How does the current year's family earnings compare to those generated in the last five years?”

• The third question is: “Are my ranch's family earnings trending up or down over the last five years?”

All three questions must be answered from your ranch's profitability accounting system in a summary number I call Net Ranch Income (NRI). So, how does one calculate NRI?

A “ranch-profitability account” generates a year's business summary where the bottom line summarizes the NRI for that business year. Figure 1 presents a simplified ranch-profitability account.

A “good” accounting system generates a total annual operating-income summary number (basically gross receipts). It also accumulates your annual business operating expense. By subtracting operating expenses from operating income, a good accounting system gives a ranch manager his ranch business's net-cash operating income (NCOI).

NCOI, however, doesn't include all business expenses. Machinery, equipment, buildings and breeding-herd depreciation must be subtracted. After that, you must adjust for the differences in beginning and ending inventories in the business.

The inventories that must be accounted for are feed and grain, market livestock (as opposed to breeding stock), accounts receivable, supplies and prepaid expenses, and accounts payable. The sum of these inventory adjustments can be positive or negative.

The bottom line of this profitability analysis is NRI (before taxes). This bottom line is used to measure the “earned-net returns” from the three resources the ranch family contributes to the ranch business:

• unpaid family and operator labor

• management

• equity (family) capital invested in the ranch business

Ranchers must know their annual earned-net returns to the family's resources each and every year they operate the ranch.

Another important, long-run question answerable with multiple years of ranch-profitability analyses is: “Is my current ranch business a profitable use of my family's resources, or should my family's resources be employed in a different manner?”

When ranchers ask me if they should change their calving date, it's really a business management question best answered by looking at alternative projected NRIs.