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Financial Statements
Thoroughly understanding your business’ financial performance is critical
for success in today’s increasingly competitive agricultural environment.
Accurate records and financial statements are the foundation material
required to analyze the financial condition and trends of your operation.
All agricultural businesses, from small part-time farms to large commercial
operations, require financial statements completed on a regular basis to
track financial progress including equity, liquidity, income, and cash flow.
2 © 2008 Northwest Farm Credit Services, Spokane, WA. All Rights Reserved. Reproduced with permission only.
BUSINESS TOOLS Preparing Agricultural
Financial Statements
sheet. Assets valued on a cost basis are listed and includes investment capital and
at the historical cost less any accumulated retained profits. In a corporate business
depreciation. Market valued assets are listed structure, owner equity will include
at fair market value based on the asset’s stockholder’s equity, additional paid-in
condition, location or other relevant factors. capital and retained earnings.
Assets valued at the lower of cost or market
are assigned either the cost value or the
market value, whichever is lower. Assets should
be separated into two categories: current and
non-current. A more detailed discussion of
asset classification will follow.
Liabilities
Liabilities include all claims against the
business by creditors, suppliers or any other
person or institution to which a debt is
owed. Liabilities, like assets, are classified Assets
into current and non-current categories.
Current Assets
Current assets are the first classification of
assets appearing on the balance sheet. Current
assets include items such as cash or assets
that can and will be turned into cash within
a year without disrupting normal business
operations. Current assets also include any
items that will be consumed within a year.
Examples of current assets include:
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can be easily turned to cash. This would non-current assets. These assets support
include only those securities which the production activities and are considered
owner intends to convert to cash within to have a life greater than one year. In
the year. Stock or other securities held for agriculture, common non-current assets
long-term investment or for retirement include machinery and equipment. Breeding
should be considered non-current assets. livestock are classified as non-current assets.
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BUSINESS TOOLS Preparing Agricultural
Financial Statements
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Owner Equity page). Owner equity reflects the owner’s
investment of capital into the business and
Owner equity is a residual amount after retained earnings which are generated over
liabilities are subtracted from assets (see time. Retained earnings are profits that have
Exhibit 1 below and Exhibit 2 on the next been reinvested back into the business rather
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BUSINESS TOOLS Preparing Agricultural
Financial Statements
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emerging with one entity holding operating When crop and livestock inventories are
assets and another entity controlling the included on the balance sheet, they should
capital assets. It is essential to identify the be accompanied by a schedule detailing the
entity for which the balance sheet is being amount and value of each item, indicating
prepared, such as business, personal or a how the total value was derived.
consolidation of both.
Often a person is involved in more than
Timing one business venture. If so, information
For analysis purposes, the timing of the about assets and liabilities associated with
balance sheet is important. Balance sheets other businesses should be identified. One
are most useful when they consistently business may show significant equity while
coincide with the timing of the income another is heavily leveraged. Lenders are
statement, usually at fiscal year-end, which likely to request a consolidated balance
is typically the end of the income period. sheet that combines all business and
The accrual adjusted income statement personal assets and liabilities.
(discussed later) combines other data,
including changes in the beginning and Valuing leases
end-of-year balance sheets. Numerous valuation issues arise when
preparing balance sheets which exceed
Asset valuation the scope of this discussion. An issue is
A balance sheet is only as valuable as the that of capital leases for items such as
quality of the information used to prepare tractors, combines, irrigation equipment,
it. When valuing assets on a market basis, a and storage structures. In the past, many
conservative approach is preferred, based lease obligations were simply included as
upon appraisals and recent sales data in footnotes to the balance sheet. However,
the market. When preparing a balance these types of leases should be included on
sheet, it’s important to distinguish between the balance sheet.
possession and ownership of assets. If a
partial interest in property is owned, then There are two types of leases: operating
only that portion should be reflected as an leases and capital leases. Operating leases
asset on the balance sheet. Ownership issues allow the lessee the right to use an asset for
also arise in the case of “life estates” and a relatively short period of time. Operating
lease agreements. leases should appear as a note to the
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BUSINESS TOOLS Preparing Agricultural
Financial Statements
balance sheet (unless prepaid or past due), • The present value of the minimum lease
similar to the rental of farm land. A capital payment equals or exceeds 90 percent
lease is a direct substitute for purchase of of the fair market value of the leased
the asset with borrowed money. It transfers property.
substantially all the benefits and risks
inherent in the ownership of the property to Exhibit 3 below, illustrates an example of
the lessee. To be considered a capital lease, a five-year capital lease agreement with
the agreement must meet any one of the annual payments (due at the beginning of
following tests: the period) of $11,991. The lease is treated
similar to an equal payment, amortized loan
• The lease transfers ownership of property and must be reflected as both an asset and
to the lessee at the end of the term. a liability on the balance sheet. Although
there is no interest rate stated in the
• The lease contains a bargain purchase agreement, an $11,991 annual payment for
option. five years at an “imputed interest rate” of 10
percent results in a present value of $50,000.
• The term of the lease is at least 75 percent This is the initial lease value (both asset and
of the estimated economic life of the liability). Remember, it’s the lease investment
property. which is being put on the balance sheet, not
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the asset being leased. • Sales price of purchased breeding
livestock exceeds the original cost.
Also in Exhibit 3, the asset is listed as a non-
current asset each year. The principal due Income statement
within the year and any accrued interest as
of the date of the statement are listed as A business income statement, also called a
current liabilities, and the remaining lease profit and loss statement, is used to measure
obligation is a non-current liability. revenues and expenses over an accounting
period. Unlike the balance sheet, which
Deferred taxes reflects the financial position at any given
As discussed earlier, assets can be valued point in time, the income statement shows
on the balance sheet, either on a cost or income and expenses for a period of time,
market value basis. A market value balance usually one year. Income statements can be
sheet reflects the impact of deferred tax used to determine income tax payments,
liabilities (refer back to Exhibits 1 and 2 on analyze a business’ expansion potential,
pages 6 and 7). Deferred taxes are the federal evaluate the profitability of an enterprise, and
and state taxes that would be incurred assist in loan repayment analysis.
if the business was liquidated. Deferred
taxes on current assets arise because many Identify entity
agricultural producers report income on a
Identifying the business entity is also
cash rather than accrual basis for income
important when preparing an income
tax purposes. Therefore, they do not pay
statement. The income statement
taxes on the accumulation of crop and
should be prepared for the same entity
livestock inventories over time. Income taxes
as the balance sheet, either business,
would be due if inventories were sold and
personal or consolidated. Because of the
if the expenses associated with them had
previously been deducted as cash expenses. interrelationship between the balance sheet
Deferred taxes may also be present on non- and income statement, the time period
current assets. Two examples of deferred tax covered by the income statement should be
situations are: the time between the beginning and ending
balance sheets. The most common period
• Market value of assets exceeds cost less is annually, although quarterly or monthly
accumulated depreciation. statements are sometimes desired.
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BUSINESS TOOLS Preparing Agricultural
Financial Statements
Depreciation
Depreciation, although not a cash expense,
is included on both the cash and accrual
income statements as a way of spreading
the cost of capital purchases over their
useful life. Accelerated depreciation is
frequently used for tax purposes. If this is
the case, it should be noted accelerated
depreciation is being used, because it could
distort profitability.
Schedule F
The Schedule F tax form is often used as an
income statement. Although the Schedule
F can offer some valuable insight, it is not
an income statement and should not be
used as such. However, in some cases it can
be used effectively if three to five years of
information is provided and the business is
in a stable operating mode with no major
adjustments. Using a series of Schedule Fs
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as an income tax statement rests on the accounting records will produce an accrual
assumption shifting income and expenses statement; however, in practice, adjustments
will even out over the years. are made to the cash income statement
(or Schedule F) to gain an accrual-adjusted
Accrual-adjusted statements income statement. Exhibit 5 above
The Farm Financial Standards Council illustrates how accrual adjustments are
recommends the use of an accrual-adjusted made. To convert cash income to accrual-
income statement. Ideally, a business’ adjusted income, we must look at changes
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BUSINESS TOOLS Preparing Agricultural
Financial Statements
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• The cash flow in a transition year before Different scenarios
the operation is fully engaged. A one-year projection can be completed for
different scenarios to examine price, cost
Components
and related impacts.
While cash flow statement formats can vary,
there are three basic components: cash Cash flow projections for multiple years may
inflows, cash outflows and operating finance also be useful when development is being
activities. done, in order to project cash needs prior to
full production or adequate production to
Exhibit 6 on the next page illustrates a break even.
cash flow projection. Cash inflows include
receipts from farm and nonfarm activities Different cash flow scenarios may include:
that are divided into relevant categories for “How would cash flow be affected if
the type of business being examined. Cash commodity prices were 50 cents lower
outflows include a detailed listing of cash than expected?” or “What is the impact of
expenses as well as principal and interest a 10 percent increase in fertilizer costs?”
payments on term debt. Testing these options helps identify
how sensitive an operation or projected
Note depreciation does not appear on the scenario is to changes in the market
cash flow projection because it’s not a cash environment. It’s important to remember
expense and will not impact cash flow. The a cash flow projection is only as good as
operating finance activities section outlines the assumptions and information used to
the net cash flows for each quarter along prepare it.
with the short-term borrowing needs,
interest accrued and repayment of the line
of credit.
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BUSINESS TOOLS Preparing Agricultural
Financial Statements
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