HARRY and his father, Ted, have been having an argument about the farm-risk profile.

Ted reckons Harry is carrying too much risk because of the area in crop, but Harry is comfortable with the situation.

As Ted stormed off, Harry phoned his sister, Jill, to chew it over. Jill is a graduate in ag science and ag economics and Harry respects her judgment.

Jill pointed out that he can't do much about it now, because this year's crop is in and up.

As long as he is tracking profit and loss, cash flow and the balance sheet, and taking management action if either goes askance, all will be OK.

But she also warned that in the past few years, although the farm has increased in value, debt has been increasing too. That means that while the balance sheet looks healthy, the increase in interest has lowered profit and if there is another tight year, cash flow could be a problem.

Harry is a good farmer and an astute manager, but he asked Jill to lead him through each of the concepts to ensure he has a good working knowledge of the farm's financial situation.

Jill explained that the taxation profit and loss report should be called the profit or loss report, because it is either one or the other.

In simple terms, the "P and L" looks at all the money in and out and makes some allowance for depreciation. On many farms the operator allowance has not been deducted from the P and L.

So a $40,000 profit, with a $35,000 operator allowance, means the profit is effectively reduced to $5000.

The balance sheet is a statement of assets and liabilities, which should point to a net figure of assets minus liabilities. This is effectively a measure of the capital used, the capital owned and the debt. Harry was happy that even before the conversation with Jill he understood those terms.

The term which tripped him up was "cash flow". Harry's wife, Sally, has done the books for years, with an annual cash-flow budget since Ted retired. So when Jill started talking about cash flow, Harry immediately thought about the farm budget.

Jill corrected Harry (as only a sister can) and pointed out that in this context, "cash flow" referred to the amount of cash that was available after tax had been paid to purchase capital items, reduce debt or invest off farm.

"Would we want to invest off farm?" he asked.

"Well," Jill replied. "Dad is fit, but he's not getting any younger and we know he wants to leave something to each of us kids. So for the long term the farm would be more secure if there was a healthy off-farm investment.

"It would help with risk management to reduce debt first."