BALANCE

SHEET
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Balance Sheet

• Summarizes the financial condition of the business

at a point in time,

• Its estimates net worth or owner equity by valuing

and organizing assets ad liabilities.

• Can change daily since farm transaction occur daily.

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Purpose and Use of a Balance Sheet

• Systematic organization of everything “owned” and

“owed”
• Assets = liabilities + owner equity

• Owner equity = assets  liabilities

• Prepared at any time, but mostly at end of accounting

period
• Provides measures of solvency and liquidity
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Solvency

• measures the liabilities of the business relative to the

amount of owner equity invested in the business.

• an indication of the ability to pay off all financial

obligations or liabilities if all assets were sold.

• If assets are not greater than liabilities, the business

is insolvent.
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Liquidity

• measures the ability of the business to meet

financial obligations
obligation as they come due without

disrupting the normal operations of the business.

• measures the ability to generate cash needed to

pay obligations.

• a short-run concept.
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Balance Sheet Format

• Assets shown on left or top

• Liabilities are shown on right or below assets

• Owner equity shown on balance sheet and

liabilities + owner equity = assets

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General Format of a Balance Sheet

Assets Liabilities

Current Assets $100 Current Liabilities $60

Noncurrent Assets 400 Noncurrent Liabilities 200

Total Liabilities $260

Owner's Equity 240

Total Liabilities and

Total Assets $500 Owner's Equity $500
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Alternative Format
Format of a Three-Category Balance Sheet

Assets Liabilities

Current Assets $100 Current Liabilities $60

Intermediate Assets 120 Intermediate Liabilities 75

Fixed Assets 280 Long-term Liabilities 125

Total Liabilities $260

Owner's Equity 240

Total Liabilities and

Total Assets $500 Owner's Equity $500
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Assets

An asset has value for one of two reasons:

1) It can be sold to generate cash,

2) It can be used to produce other goods that in

turn can be sold for cash in the future.

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Current Assets

• can be sold easily to generate cash are called

liquid assets.
• E.g.
• cash,
• marketable stocks and bonds,
• accounts receivable,
• inventories of feed, grain, supplies and feeder
livestock.
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Noncurrent Assets

• more difficult to sell and/or their sale would be

more likely to disrupt the business.
• E.g.
• machinery,
• equipment,
• breeding livestock,
• buildings, and
• land.
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Liabilities

• A liability is an obligation or debt owed to someone

else.
• It represents an outsider’s claim by others on the
business.
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Current Liabilities

• Are financial obligations that will become due and

payable within one year from the date on the balance sheet.

• Examples:
• accounts payable,
• principal and accrued interest on short-term loans,
• principal due within one year on longer term loans.
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Noncurrent Liabilities

• These financial obligations will become due and

payable some time after one year from the date on

the balance sheet.

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Owner Equity

• If all assets were to be sold and all debts paid on the date of
the balance sheet, the owner’s equity would be the amount
left over.
• changes when:
1. the business has a profit or loss,

2. the owner invests more capital from outside the

business
3. the owner invests withdraws money from the
business,
4. assets change value.
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 Owner equity does not change when cash is used to buy

other assets or a loan is taken out to purchase an asset with

value equal to the loan.

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Asset Valuation and Related
Problems

• A cost-basis balance sheet has all assets valued

following the cost, cost less depreciation, or farm
production cost methods except inventories of grain and
market livestock.

• A market-basis balance sheet has all assets

valued at market value less estimated selling costs.
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Which is best?

• Cost-basis balance sheets conform to general accounting

standards and are thus comparable to balance sheets from

other types of businesses.

• Market-basis balance sheets more accurately reflect the

actual financial position.

• both types of balance sheets are needed for proper

business analysis.
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Valuation Methods for Cost-Basis and Market-
Basis Balance Sheets

Cost M arket
Asset Basis Basis

Marketable securities Cost Market

Inventories of grain and
market livestock Market* Market
Accounts receivable Cost Cost
Prepaid expenses Cost Cost
Investment in growing crops Cost Cost
Purchased breeding livestock Cost Market
Raised breeding livestock Cost or a Market
base value
Machinery and Equipment Cost Market
Buildings and Improvements Cost Market
Land Cost Market

*Market is acceptable for raised grain and market livestock

Lower of cost or market is preferred for purchased grain and
market livestock
 Balance Sheet for I.M. Farmer, December 31, 20XX
Assets Liabilities

Currrent Assets: Cost Market Current Liabilities Cost Market

Cash/checking acct. $5,000 $5,000 Account Payable 6,000 6,000

Marketable securities 1,000 2,200 Notes payable within 1 year 15,000 15,000
Inventories Current portion of term debt 28,000 28,000
Crops 40,000 40,000 Accured Interest 15,700 15,700
Livestock 52,000 52,000 Income taxes payable 8,000 8,000
Supplies 4,000 4,000 Current portion - deferred taxes 15,020 15,260
Accounts receivable 1,200 1,200 Other accrued expenses 900 900
Prepaid expenses 500 500 Total Current Liabilities $88,620 $88,860
Investment in growing crops 7,600 7,600
Other current assets 0 0 Noncurrent Liabiltiies Cost Market
Total Current Assets $111,300 $112,500
Notes payable
Machinery 20,000 20,000
Noncurrent Assets: Cost Market Breeding Livestock 40,000 40,000
Real estate debt 175,000 175,000
Machines and equipment 67,500 95,000 Noncurrent portion - deferred taxes ------ 45,000
Breeding livestock (purch.) 48,000 60,000 Total Noncurrent Liabilities $235,000 $280,000
Breeding livestock (raised) 12,000 24,000 Total Liabilities $323,620 $368,860
Buildings and improvments 27,000 50,000
Land 288,000 400,000 Owner Equity
Other noncurrent assets 0 0
Total Noncurrent Assets $442,500 $629,000 Contributed capital 50,000 50,000
Total Assets $553,800 $741,500 Retained earnings 180,180 180,180
Valuation adjustment ------- 142,460
Total Equity $230,180 $372,640
Total liabilities and owner equity $553,800 $741,500
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Balance Sheet Example

• Assets: most differences show up in valuation of

noncurrent assets
• Liabilities: Little difference in liabilities sections, other

than deferred taxes

• Owner equity: valuation adjustment on market-basis

balance sheet accounts for change in assets’ worth over

time because of changes in market conditions for item
 Asset Valuation Methods
• Conservatism : cautions against placing too high a value on ant
asset
• Consistency: refers to using same valuation method over time
• Methods:
1. Market value - current net market price excl. transport,
VAT etc
2. Cost: - purchase value
3. Lower of Cost or Market - using the lowest of either cost
or market value
4. Farm production cost: - accumulated cost of producing
the item
5. Cost less accumulated depreciation: - book value
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Balance Sheet Analysis

Liquidity measures: Solvency measures:

1. current ratio, 1. debt/asset ratio,

2. working capital
2. equity/asset ratio,
• Other measure:

1. debt structure 3. debt/equity ratio,

ratio
4. net capital ratio
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Current Ratio

Current asset value

=
Current liability value

$112,500
Current ratio = = 1.27 (market value)

$88,860
• greater than 1 preferred
• It’s a safety margin for price changes
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Working Capital

= Current assets  Current liability

Working capital = $112,500  $88,860 = $23,640

(market value)

• Safety margin for liquidity measured in dollars

• Money available to buy inputs
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Solvency
Debt/Asset Ratio

Total liabilities
=
Total assets

$368,860
Debt/asset ratio = = 0.50
$741,500
(market value)

• Smaller ratios preferred, less than 1

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Equity/Asset Ratio

Owner equity
Equity/asset ratio =
Total assets
$372,640
Equity/asset ratio = = 0.50
$741,500
(market value)

• Part of assets financed by equity, preferred higher ratios,

but not more than 1
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Debt/Equity Ratio

Total liabilities
Debt/equity ratio =
Owner equity

$368,860
Debt/equity ratio = = 0.99
$372,640
(market value)
• Smaller ratios preferred,
• proportion of finance provided by lenders to that of
business owners
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Summary of I.M. Farmer’s Financial Condition

Measure Market Ratio

Liquidity
Current ratio 1.27
Working capital $23,640

Solvency:
Debt/asset ratio 0.50
Equity/asset ratio 0.50
Debt/equity ratio 0.99
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Net Capital Ratio

Total assets
Net capital ratio =
Total liabilities

$741,500
Net capital ratio = = 2.01
$368,860
(market value)
• Measures solvency,
• higher ratios preferred
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Debt Structure Ratio

Current liabilities
Debt structure ratio =
Total liabilities

$88,860
Debt structure ratio = = .24 or 24%
$368,860
(market value)

• Proportion of current liabilities to the total liabilities

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Statement of Owner Equity

• The statement shows the sources of change in

owner equity over the accounting period.

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Statement of Owner Equity

Owner equity, January 1, 2003 $344,490

Net farm income for 2003 47,900
Less adjustment for income taxes paid and payable (8,150)
Net after-tax farm income 39,750
Less increase in current portion -- deferred income taxes (1,600)
Owner withdrawals from farm business (36,000)
Nonfarm income contributed to farm business 9,500
Net owner withdrawals from farm business (26,500)
Other capital contributions to farm business 0
Other capital distributions from farm business 0
Increase in market value of farm assets 22,500
Less increase in noncurrent portion of deferred income taxes (6,000)
Net increase in valuation equity 16,500

Owner equity, December 31, 2003 $372,640

FARM MANAGEMENT
Chapter 6
The Income Statement
and Its Analysis
 farm management chapter 6 35

What is an Income Statement?

• a summary of revenues and expenses as recorded

over a period of time.

• Summarizes financial transactions that affected

revenue & expenses over a period of time.

• Provides an estimate of farm net income /profit

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Relation Between Balance Sheet And Income
Statement
 Depreciation
• annual in value due to use, wear, tear, age and

technical obsolescence.
• Reduces annual profit & a reduction in the whole value

of the assets
• Which assets to be depreciated?

1.A useful life of more than one year

2.A determinable useful life but not an unlimited life

3.A use in business for the depreciation to be a business expense

 Terms
• Cost: price of asset+ VAT + delivery fees + installation
incl. directly related expenses to put it into use

• Useful life: number of years the asset is expected to be

used in business before it is completely worn out

• Salvage value: expected market value of the asset at the

end of its assigned useful life.

• Book value: the asset’s cost less accumulated

depreciation. Not market value
Depreciation Methods

• Choice: type of asset, pattern of use, rate of market value

decline
1.Straight line methods
2.Declining Balance
3.Partial –Year Depreciation

Straight Line Depreciation

Annual depreciation = [Cost – Salvage value] / useful life
= [ costs – salvage value] * R
R= annual straight line % rate = 100%/useful life
E.g. Straight Line Depreciation
• Buy a tractor @ E10 00 with E2 000 salvage value and a
10year useful life.
•
• [E10 000 – E2 000]
10yrs = E800 per annum
OR

[ 10 000 – 2 000] * 10% = E 800 per annum

where R= 100%÷ 10 = 10%
 Declining Balance

• Annual depreciation=

[ book value at beginning of the year ] * R

R = same used every year

- multiples of straight line deprecation R

- can be double or fractional

- i.e. 20% = double [ 10%*2], even 17.5%, 15%, 12.5%

• R * each years book value

• No salvage value consideration

 Declining Balance
e.g.
• Buy a tractor @ E10 00 with E2 000 salvage value and a
10year useful life.
• where R= 100%÷ 10 = 10%
• Using double declining balance
Double Declining Balance
Partial Depreciation
• When only a portion of the year Is to depreciated
• E.g. October to December = 3/12

• What about:
• March to December?
• July to December?