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Balance Sheet - A FinancialManagement Tool

Curriculum Guide I. Goals and Objectives:

A. Understand the purpose of a balance sheet.B. Understand how to complete a balance sheet.C. Understand how the balance sheet can be used to evaluate the business.

II. Description/Highlights

A. A balance sheet is a statement of the financial condition of the business at a specificpoint in time. It is one of the principal reports provided by a good accounting system. The balance sheet shows what is owned in a business, what is owed, and the owner’sshare or net worth of the business. By comparing past balance sheets with the presentbalance sheet, the growth or decline of assets, loans and net worth of a business can bedetermined.

B. The balance sheet shows the amount of funds the owner has in the business. Todetermine this amount, the assets owned are listed and a value is placed on them. Thetotal value of liabilities also are listed. The difference between assets and liabilitiesequals net worth which represents the owner’s equity in the business. The balancesheet if often called a net worth statement. The net worth is equivalent to the valuewhich would be left if all of the business account and debt obligations were paid in full.

C. Assets may include cash on hand, bank accounts, accounts receivable, feed supplies,livestock, equipment, buildings, land other items. Although each asset may not becompletely paid for, its full value is listed. The unpaid accounts notes and mortgagesare listed as liabilities.

D. In many farm businesses, there is no sharp distinction between farm business andnonfarm assets and liabilities of the farm family. This is particularly true where thefarm and family living expenses are paid for out of the same bank account. Funds mayflow back and forth from farm to nonfarm items. In this kind of a situation, the balancesheet may include both farm and nonfarm items.The relationship of assets, liabilities, and net worth is expressed as follows:

Assets - Liabilities = Net Worth (Equity) OR

Assets = Liabilities + Net Worth (Equity)This accounting equation is expressed in the example balance sheet.

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E. A current asset is cash or other assets that can be quickly converted into cash in thenormal business processes within one year. The value of current assets may varygreatly over time. Crops may be harvested but held for a better market. Feederlivestock may be purchased or sold, resulting in a continual cash flow of funds into thebusiness and out again.

F. Noncurrent assets are those resources that are used mainly to support farm production. Unlike current assets, they are not expected to be sold in the normal business process. These assets have a more permanent value. They are needed to produce income, butmay not be easily converted to cash. They include breeding livestock, machinery andequipment, buildings, and real estate.

G. Current liabilities are notes payable within a year, and include accounts payable,accrued interest and other expenses, income taxes payable, and current portion ofdeferred taxes. When they become due, they are usually paid from cash on hand or bycreating another loan.

H. Noncurrent liabilities include the noncurrent portion of notes payable; as well as landcontracts and mortgages on land and buildings-improvements. Portions of thenoncurrent liabilities that are due with 12 months are current liabilities because they aredue in the present year of the business.

I. The balance sheet has many important uses. Lending agencies use balance sheets toevaluate the financial position of most loan applicants. The balance sheet statementalso can be extremely useful to the owner of the business indicating the state ofbusiness net worth. Comparison of balance sheets over time will show how much thebusiness net worth is growing or decreasing. A balance sheet can be used by the ownerof a business to support a request for borrowed funds.

J. One of the most important issues in completing and using the balance sheet is themethod used to value assets. The two most common are current market value andcost. Market value is the estimated amount the asset would sell for on the date of thestatement less selling costs. Cost is the original cost or basis of the asset less anyaccumulated depreciation. In addition to affecting financial ratios derived from thebalance sheet and the amount of deferred taxes, the biggest issue is the impact on farmequity.

K. One of the most important issues in completing and using the balance sheet is themethod used to value assets. The two most common are current market value andcost. Market value is the estimated amount the asset would sell for on the date of thestatement less selling costs. Cost is the original cost or basis of the asset less anyaccumulated depreciation. In addition to affecting financial ratios derived from thebalance sheet and the amount of deferred taxes, the biggest issue is the impact on farmequity.

L. The National Farm Financial Standards Council recommends that the balance sheetshould be prepared on both a market and a cost basis. The cost basis indicates the

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amount of earned and contributed owner equity. The market value indicates theadditional amount of equity that has resulted from the change is asset values due toinflation or deflation. The portion of total equity that has resulted from market valuechanges is the difference between the market value and cost basis owner equity.

M. One of the most effective methods of evaluating the balance sheet is comparison of oneyear to previous years for the same business. Comparison of balance sheets betweenyears directs attention to changes that have occurred in the relationship between assetsand liabilities and the resulting growth or decline in net worth of the business.

N. Comparison of the balance sheet of a farm business to balance sheet data fromsuccessful farms of a similar type may give evidence of weak or strong points in thebusiness.

O. Ratios may be used in evaluating balance sheets. A ratio is a comparison of twonumbers which are expressed as a numerical ratio of one number to the other or as apercentage of one to the other.

P. When different sized operations are compared, use of percentages rather that actualdollars has some advantages. This approach is called a common-size statement. Eachfarm is put on a “common-size” basis; that is, the various assets, liabilities, and equityare expressed as percentages within the business.

III. Potential Speakers

A. Extension economistsB. Local lendersC. Local accounts

IV. Review Questions

A. What does the balance sheet show? The financial condition of the business at a specificpoint in time.

B. What are the three major components of a balance sheet? Assets, liabilities, and networth.

C. What is the difference between market value and cost? Market value is the estimatedamount the asset would sell for on the date of the statement less selling costs. Cost isthe original cost or basis of the asset less any accumulated depreciation.

V. For More Details

Agricultural Financial Reporting and Analysis. Arnold W. Oltmans, Danny A. Klinefelter andThomas L. Frey. Doane Agricultural Services, St. Louis, Missouri. 1992.

Financial Management in Agriculture. Peter J. Barry, Paul N. Ellinger, C.B. Baker and JohnA. Hopkin. Interstate Publishers, Inc., Danville, Illinois. 1995.

Balance Sheet -A Financial Management Tool

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!! What is a Balance Sheet

L A financial statement which shows the financialcondition of the business at a specific time

!! The Balance Sheet Relationship

L Assets - Liabilities = Net Worth (Equity)

!! Definitions

L Assets - the value of those things owned by orowed to the business

L Liabilities - the amounts owed by the business

L Net Worth - the amount the owners would haveleft if all liabilities were paid

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!! Statement Structure

L Current Assets - Assets that are cash, near cashor that will be converted into cash within oneyear

L Noncurrent Assets - Assets used mainly tosupport farm production. They are notexpected to be sold in the normal businessprocess.

L Current Liabilities - Liabilities payable withinone year, including the current portion ofnoncurrent liabilities.

L Noncurrent Liabilities - Liabilities payablebeyond one year.

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!! Asset Valuation Methods

L Market Value - The estimated amount an assetwould sell for on the date of the statement lessselling costs.

L Cost - The original cost or basis of an asset lessany accumulated depreciation.

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!! Uses of the Balance Sheet

L To determine how much the business is worth

L Comparisons of balance sheets over time showtrends in financial strength and structure

L To support loan requests

L To provide information for estate planning

L To help analyze the business’ ability to bearrisk

L To provide year end values for accrued assetsand liabilities which are needed in measuringbusiness profitability

L When prepared on both a cost and market valuebasis, it can show how much of the change infinancial position is due to reinvested earnings,(losses) and how much is due to inflation(deflation)

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!! Evaluation Methods

L Comparisons over time

L Comparisons to the other farms

L Ratio Analysis

L Common-size statements