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Creating and Understanding Your Balance Sheet

In a down cycle, many producers focus first on cash flow, seeking places to trim costs and assessing whether income will cover expenses. But it’s important to also pay attention to the farm’s balance sheet because it addresses an operation’s long-term viability.

A balance sheet is quite straight-forward: Current and noncurrent assets are listed on one side, current and noncurrent liabilities on the other side. The difference in the totals is an operation’s equity – a point-in-time snapshot of an operation’s solvency.

Most businesses update their balance sheet at the end of the accounting period, such as the end of the tax year. Some check their numbers quarterly. Lenders will ask to see up-to-date balance sheets to determine an operation’s net worth, as well as to generate a number of ratios that provide insights into your operation’s financial health.

Assets

Let’s look first at the asset side of the balance sheet. Assets are everything owned by a business or individual. Current assets are considered “liquid”—those that are cash or can be turned into cash promptly, including checking and savings accounts or mutual funds, stored production (such as grain in the bin), market livestock and growing crops, feed on hand, paid-for but not yet used inputs or other supplies, and accounts receivable.

Noncurrent assets are those that can’t be readily sold, such as machinery and equipment, vehicles, breeding livestock, co-op stock, farmland, your house, other buildings, or a retirement account that is subject to government withdrawal penalties, etc.

Liabilities

Current liabilities are those that are due right away—usually within the next 12 months. These include accounts payable (such as for inputs, or land rent), farm taxes, current notes and credit lines, accrued interest on operating or term loans, the current portion of principal due in 12 months, credit card debt or loan payments to family members.

Noncurrent liabilities include loans used to purchase assets that have a life-span of more than a year, such as vehicles, machinery, farm ground or a home. They also could include an agreement to buy out a partner or a parent’s share of the business.

Valuation Issues

While the concept of a balance sheet is fairly simple, it is not without gray areas. For instance, how do you value grain in a bin or market livestock? Machinery or equipment? Farmland? Do you use a cost basis or market basis? In some cases, the resulting value can be quite different.

For production of commodities such as grain and livestock, using a market valuation makes sense. The market price might be one that is locked in on a sales contract or a local destination’s delivery price. While the value of unsold inventory changes daily, producers commonly use prices for the date their balance sheet is completed to capture the value of their assets.

Putting a value on vehicles or machinery is more difficult. A piece of machinery that cost $250,000 new will be valued differently at today’s replacement cost or trade-in market value. Depreciation is used by many producers to account for changes in value. Just be sure to depreciate every year to ensure consistency in tracking values and to capture any moves in the market for resale or trade purposes.

The value of farmland and other noncurrent assets also changes over time. Again, consistency is key. If you always carry assets at a cost basis, continue to do so. This will help you avoid any misrepresentation of a balance sheet due to variances to the market over time.

Liabilities are a bit easier: Terms of loans are spelled out and the repayment amount as of a given day, even for credit cards, generally can be accessed online.

An easy check and balance is to match assets to liabilities. Most assets will match up to a liability. For instance, if a growing crop is listed as an asset, check that accounts payable for associated seed, fertilizer and chemical have been included as liabilities.

The Bottom Line

The balance sheet is a tool to identify and determine the strength of your operation or your reserve risk-bearing capacity. If you are consistent in how and when you capture your assets and liabilities, it is easy to see your operation’s financial progression from one year to the next. It also is important to share with your lender your chosen methods for tracking the value of your assets so everyone has a clear understanding of your operation’s financial health.

AgriPoint®, one of the free digital tools available to customers of Frontier Farm Credit, includes a worksheet with current assets and liabilities, followed by noncurrent assets and liabilities. When you click a category, it provides a drop down menu of items that fit the category. You can enter what the item is and the amount. As you progress through the form, it automatically calculates your working capital and net worth. When you are finished, you can save your balance sheet for future use, and a click of a button will turn it into a PDF you can file or email, etc.


Uses of the Balance Sheet

Balance sheets are a great tool to evaluate alternative debt structure options that will assist in managing through difficult times. Whether you are creating a balance sheet for your banker or for your own use, here are some measures of your financial position that your balance sheet will provide:

  • Solvency measures the relationships among assets, liabilities and equity to assess “health” of your operation.
  • Liquidity measures the operation’s ability to meet current financial obligations as they come due without disrupting normal business—the ability to generate cash in the short-term.
  • Trends: As you update your balance sheet from year to year, you can see whether your business is progressing—whether equity is growing or shrinking, and whether you are maintaining adequate liquidity.

AgriPoint® includes an option to create trend reports, which show how your operation has been performing historically. The online tool also can run scenarios on how a purchase – or change in price – would affect various aspects of your operation and bottom line.

financials

Cash-flow Budgeting: About Amount and Timing

Cash-flow budgets can be difficult to create for a farm business, but they are important to lenders for two reasons. First, lenders want to know if income from a farm will be more than the expenses. Secondly, will a producer be able to pay bills on time?

While producers generally know when bills are due and production will be ready for market, input costs and production sales prices often are entered as estimates on cash-flow budgets – and these can vary greatly. As a result, many producers update cash-flow projections quarterly or even monthly.

The steps outlined below are key to helping you and your lender understand your cash flow for the year.

Cash Inflows

Inventory any production on hand, whether it is crops in storage or market livestock. If you have a recent balance sheet, these would be in current assets. Next, estimate when and for how much you might sell that production. If you’ve already contracted part of the production, enter the quantity, delivery period and price for that portion. For any remaining production, producers often pencil in the current futures price (adjusted for their local basis) for the month in which they expect to deliver production.

Next, include line items for other income, such as government payments of any kind, crop insurance indemnity, custom work, farm rent paid to you, interest, etc. Sales of capital assets, if any, would have a line of their own. Separately, add any short-term and long-term loans you have made that will be repaid. Finally, include any non-farm income that applies to your operation.

Cash outflows

Calculate your operating costs. For crops, this includes seed, fertilizer/lime, chemicals, crop insurance, drying costs, and any custom hire or machinery rental. A case can be made that an amount should be set aside for marketing—an advisory or information service, brokerage fees, etc.

If you have livestock, include any purchased crops/feed, purchased livestock, vet and health product costs and marketing expenses.

Next, enter fixed expenses, overhead, or other expenses not allocated to a specific enterprise. Examples include real estate taxes; cash rent; hired labor; machinery repairs, upkeep, fuel and lubrication; and equipment leases.

Purchases of capital assets (total for the year) warrant a line item.

Also on the debit side is financing: accounts payable, short-term notes due, long-term loan payments and any installment contract payments.

Finally, include an estimate of taxes due and family living expenses—unless family living is financed from off-farm income. If the manager doesn’t draw a salary, a “return to management” and/or a profit target should be included, as should any planned off-farm investments.

Bottom Line

The resulting calculation of income minus expenses lets you know whether your business will cash flow. Looking at the different time periods tells you whether you need to move income into specific months to cover expenses.


AgriPoint® includes an annual cash-flow budget tool that is free to customers of Frontier Farm Credit. It does not allow entries by month, but its drop-down menus help categorize income and expenses. Kansas State University offers detailed crop and livestock budgets.