by: Eric Richer, OSUE Fulton County
Many of us make New Year’s resolutions as we turn the corner to a new calendar year. One of the best financial management resolutions you can make is to update your balance sheet in a timely and precise fashion. The balance sheet is a “snap shot” in time of your farm’s financial position, including what assets you own and how they are financed. The balance sheet is also known as the net worth statement. When completed precisely and timely, the balance sheet and corresponding ratios can be a very valuable tool to determine farm financial health. The balance sheet objectively measures farm business growth, liquidity, solvency, and risk capacity.
Categorizing Balance Sheet Items
Balanced sheets are organized with two sides: assets and liabilities. The left side contains items categorized as assets and the right side contains liabilities. Assets are items owned by the farm business that contribute value such as cash or grain inventory. Assets also include items such as equipment or farmland that, although they are being financed, contribute to the general value of the farm business. These assets will be shown on the balance sheet with the liability or debt that needs to be paid, such as farmland with a mortgage or a tractor with a loan. Other liabilities listed on the balance sheet include outstanding financial obligations for farm expenses such as feed or fuel oil. In addition to financing with debt or liability, assets can be financed with equity, or a mix of equity and debt. Equity for financing is the debt-free capital (or cash) retained by the farm with no financial obligation.
The assets and liabilities on the balance sheet (including the financing of the assets) are used to determine the equity, or net worth, of the farm owner. The owner’s equity is used by lenders and insurers to determine a farm business’ value. There are two ways to calculate the owner’s equity, or net worth. The first simply subtracts the liabilities from the assets:
Assets – Liabilities = Owner’s Equity
The second calculation adds the owner’s equity with liabilities to determine the assets:
Liabilities + Owner’s Equity = Assets
Terms of Assets and Liabilities
Beyond the broad categories of either an asset or liability, a balance sheet categorizes items into “time compartments” or terms of useful life. Useful life is a term for the amount of time an item can be utilized for the farm business. Depreciation allocates the cost of this asset over its useful life. Both assets and liabilities can be categorized into current, intermediate, and long, or fixed, terms of useful life.
Assets – Current assets can be converted to cash in one year or less. Common current assets are cash, growing crops, harvested crop inventory, market livestock, accounts receivable, and other similar items. Intermediate assets have an assumed useful life or depreciable value of one to ten years. Common intermediate assets are breeding livestock, machinery and equipment, titled vehicles, and not-readily-marketable bonds and securities. Long term, or fixed, assets are typically permanent items with value—depreciable or not—for more than ten years and include farmland, buildings, farmsteads, and other similar items.
Liabilities – Current liabilities are obligations that are due and payable in the next twelve months. Most common current liabilities include accounts payable (bills), credit card bills, operating lines of credit, accrued interest, and the current portion of principal on loans due this year. Intermediate liabilities are obligations that due to be paid back within one to ten years and are usually associated with intermediate farm assets on the left side of the balance sheet. Common intermediate liabilities are the principal remaining on machinery and equipment loans or breeding livestock purchases. Finally, long term, or fixed, liabilities are debts with terms greater than ten years like the principal balance remaining on a farmland or building mortgage.
Assets: Market Value vs. Cost Value
The asset side of the balance sheet may have two columns for value: market and cost. Both values should be on a balance sheet to help the farmer and farm advisors, and indicate changes to the owner’s equity.
Market value – Today’s market values minus selling costs are used to determine market value. For example, a fully depreciated 15-year-old tractor certainly has a current market value greater than zero, especially in today’s environment. A realistic current market value for this tractor can be obtained with an appraisal, or by looking at current sales of similar tractors online. Similarly, farmland bought 30 years ago likely has a different current market value today. In general, lenders may prefer the use of current market values in a balance sheet for asset valuation.
Cost value – The net book value, or the cost of the item minus accumulated depreciation, is the cost value. For example, a fully depreciated 15-year-old tractor has a cost value of $0 in a cost-based balance sheet. No appraisal is needed; only record the cost minus accumulated depreciation. Farmland (a non-depreciable, long term asset) purchased 30 years ago has a balance sheet value of the purchase cost. In general, accountants prefer cost value balance sheets as a more clear reflection of business success, based on business decisions rather than inflation, depreciation, or appreciation of investments.
In a precisely completed balance sheet, the cost value and the market value columns usually produce different total asset values.
Keys to Completing the Balance Sheet
Several keys can help farmer improve their accuracy, effectiveness, and efficiency for completing year-end balance sheets.
- Complete the balance sheet on the same date each year, usually as of December 31st. The information will never be more accurate than immediately after the end of the year.
- Items like investment/retirement account balances or principal loan balances make take several weeks to arrive unless you use online accounts; nevertheless, December 31st is the reference date you should use.
- Inventory all assets, including standard weight and measure units (ie. Lbs, head, bushels, bales, etc).
- Utilize current market prices for crop and livestock inventories.
- Calculate cost value for growing crops.
- Include government payments and insurance indemnities yet to be received in accounts receivable.
- Apply conservative breeding livestock values, avoiding large year-to-year changes.
- Maintain a separate, easy-to-update depreciation schedule for depreciable assets like equipment.
Balance Sheet Tools
Several methods for completing balance sheets are available, including hardcopies like the Ohio Commercial Farm Account Book available through your local Ohio State University Extension office, spreadsheet-based software programs with templates and accounting formulas, or accounting software linking balance sheet values with online resources. Ohio State University (OSU) Extension has a Microsoft Excelâ spreadsheet-based balance sheet with farm templates that can be found at https://go.osu.edu/BalanceSheet. The most important aspect is timely and accurate entries, regardless of the method used for creating the balance sheet. Each method has drawbacks and advantages and the choice of computer versus paper based systems usually comes down to personal preference.
Balance Sheet Ratios to Evaluate Financial Health
A balance sheet is an accounting statement needed by a farmer to evaluate his or her financial health. An income statement and a statement of cashflows are also needed to provide the entire financial picture. These three statements can be used with the Farm Finance Scorecard available online by searching the University of Minnesota’s Center for Farm Financial Health.
The scorecard uses these three accounting statement to determine financial ratios and measurements to benchmark a farm operation against acceptable industry standards.
An annual comparison of the same farm, referred to as a vertical analysis, can be used to evaluate the health of a balance sheet. With vertical analysis, one year’s balance sheet totals can be added to a spreadsheet with entries from previous years for comparison. Additionally, the spreadsheet would be used for upcoming years to continue the vertical analysis. This analysis does not benchmark a farm against the industry but, instead, shows the growth achieved and trends developed by the farm over time.
References:
Hachfeld, G. A., D.B. Bau, C.R. Holcomb. 2016. Balance Sheet. Farm Financial Series, #1, University of Minnesota Extension.
Langemeier, M. R. 2011. Balance Sheet—A Financial Management Tool. MF-291, Department of Agricultural Economics, Kansas State University Extension. Available online at: www.agmanager.info