Packet #5


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Packet #5

  1. 1. Chapter 5 The Balance Sheet & Its Analysis
  2. 2. Balance Sheet <ul><li>Balance Sheet: summarizes the financial condition of the business at a point in time </li></ul><ul><ul><li>Estimate of owner’s equity (net worth) </li></ul></ul><ul><ul><li>Can change daily </li></ul></ul><ul><li>Income Statement: summarizes those financial transactions that affect revenue and expenses over a period of time </li></ul><ul><ul><li>Estimate of profit </li></ul></ul>
  3. 3. Purpose of Balance Sheet <ul><li>Organizes everything “owned” and “owed” at a given point in time </li></ul><ul><li>Asset: anything of value owned by indiv. or business </li></ul><ul><li>Liability: debt or financial obligation owed </li></ul><ul><li>Balance sheet lists assets, liabilities, and the difference between them is the owner’s equity </li></ul>
  4. 4. Purpose of Balance Sheet <ul><li>Owner’s Equity: Assets minus Liabilities </li></ul><ul><ul><li>Amount owner has invested in the business </li></ul></ul><ul><li>Most balance sheets done at end of year (Dec.31) </li></ul>OE = A - L
  5. 5. Measure Financial Position <ul><li>Once a balance sheet is completed, the financial position can be analyzed </li></ul><ul><li>Solvency: measures the liabilities of the business relative to the amount of owner equity invested in the business </li></ul><ul><ul><li>Indicates ability to pay off all financial obligations is all assets were sold </li></ul></ul>
  6. 6. <ul><li>Liquidity: measures the ability of the business to meet financial obligations as they come due without disrupting the normal operations of the business. </li></ul><ul><ul><li>Measures the ability to generate cash at the time it is needed </li></ul></ul><ul><ul><li>Short-run concept </li></ul></ul>Measure Financial Position
  7. 7. Balance Sheet Format <ul><li>Assets Liabilities </li></ul><ul><li>Current Assets xxx Current Liabilities xxx </li></ul><ul><li>Noncurrent Assets xxx Noncurrent Liabilities xxx </li></ul><ul><li>Total Liabilities xxx </li></ul><ul><li>Owner’s Equity xxx </li></ul><ul><li>Total Liabilities and </li></ul><ul><li>Total Assets xxx owner’s equity xxx </li></ul>
  8. 8. Assets <ul><li>Value by being sold to generate cash or it produces other goods that could be sold to generate cash </li></ul><ul><li>Current Assets: will be used up or sold within one year (liquid) </li></ul><ul><ul><li>Ex: accounts and notes receivable, inventories of grain, feed, supplies </li></ul></ul><ul><li>Noncurrent Assets: any asset that is not a current asset </li></ul><ul><ul><li>Ex: machinery, equipment, breeding livestock, land </li></ul></ul>
  9. 9. Liabilities <ul><li>Current Liabilities: financial obligations that will be due within one year </li></ul><ul><ul><li>Ex: accounts payable at farm supply store, principle and interest on loans, accrued property taxes, accrued wages, employee tax withholdings, income taxes payable </li></ul></ul><ul><li>Noncurrent Liabilities: obligations not due within the year </li></ul><ul><ul><li>Ex: principle due on twenty year loan for next 19 years </li></ul></ul>Mortgage
  10. 10. Owner Equity <ul><li>Owner Equity: amount of money left for the owner if all assets were sold and all liabilities paid off on the date of the balance sheet </li></ul><ul><li>Also called Net Worth </li></ul>
  11. 11. Asset Valuation and Related Problems <ul><li>2 –methods: </li></ul><ul><li>COST BASIS & MARKET BASIS </li></ul><ul><li>Market Basis: values assets at market value minus selling costs </li></ul><ul><li>Cost Basis: values assets at either cost, cost minus depreciation, or farm production cost </li></ul><ul><ul><li>More conservative </li></ul></ul>
  12. 12. Both Required!!! <ul><li>Using cost basis everything is valued at Cost </li></ul><ul><li>Using market basis everything is valued at Market price </li></ul><ul><li>EXCEPT . . . </li></ul><ul><ul><ul><ul><ul><li>Inventories of grain and market livestock MARKET Accounts Receivable COST Prepaid Expenses COST </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Investment in Growing Crops COST </li></ul></ul></ul></ul></ul>
  13. 13. Balance Sheet Example <ul><li>Asset Section </li></ul><ul><ul><li>Inventory valued at market in both cases </li></ul></ul><ul><li>Liability Section </li></ul><ul><ul><li>Income taxes payable (taxes due on taxable net farm income for past year) </li></ul></ul><ul><ul><li>Current Deferred income taxes (taxes that would be paid on revenue from the sale of current assets minus any tax deductible expenses) – NO taxes payable at this time </li></ul></ul><ul><ul><li>Noncurrent Deferred income taxes (estimate of taxes that would result from liquidation of assets at market value) </li></ul></ul>
  14. 14. Owner Equity <ul><li>3 sources </li></ul><ul><li>1) Capital contributed by owner to business </li></ul><ul><li>2) profit left in business (not withdrawn) </li></ul><ul><li>3) change caused by fluctuating market values when market valuation is used (not cost) </li></ul>
  15. 15. Example: Table 5-4 <ul><li>Locate the Contributed Capital in the Owner’s equity section for $50,000 </li></ul><ul><li>Retained earnings: income not used for living expenses, income taxes, or other purposes that remain in the business </li></ul><ul><ul><li>$180,180 in the table </li></ul></ul><ul><li>Valuation Adjustment: when an asset’s market value is more than it’s cost it creates equity </li></ul><ul><ul><li>Only use in the Market Basis Valuation, not the Cost Valuation </li></ul></ul>
  16. 16. Balance Sheet Analysis <ul><li>Ratios : measure the relative strength or weakness of a business </li></ul><ul><li>Allows businesses of various sizes to be compared </li></ul><ul><li>Help make lending decisions </li></ul>
  17. 17. Liquidity <ul><li>CURRENT RATIO </li></ul><ul><ul><li>Current Assets / Current Liabilities </li></ul></ul><ul><ul><li>Ex: $112,500 / $88,860 = 1.27 </li></ul></ul><ul><ul><li>Values over 1.0 preferred </li></ul></ul><ul><ul><li>Interpret </li></ul></ul><ul><li>WORKING CAPITAL </li></ul><ul><ul><li>Current Assets – Current Liabilities </li></ul></ul><ul><ul><li>Ex: $112,500 - $88,860 = $23,640 </li></ul></ul>
  18. 18. Solvency <ul><li>DEBT / ASSET RATIO </li></ul><ul><ul><li>Total Liabilities / Total Assets </li></ul></ul><ul><ul><li>Ex: $368,860 / $741,500 = 0.5 </li></ul></ul><ul><ul><li>Want less than 1.0 </li></ul></ul><ul><li>EQUITY / ASSET RATIO </li></ul><ul><ul><li>Total Equity / Total Assets </li></ul></ul><ul><ul><li>Ex: $372,640 / $741,500 = 0.50 </li></ul></ul><ul><ul><li>High values preferred </li></ul></ul><ul><li>DEBT / EQUITY RATIO </li></ul><ul><ul><li>Total Liabilities / Owner equity </li></ul></ul><ul><ul><li>Ex: $368,860 / $372,640 = 0.99 </li></ul></ul><ul><ul><li>Small values preferred </li></ul></ul>
  19. 19. Statement of Owner’s Equity <ul><li>The balance sheet shows the owner’s equity, but does not shoe how much it has changed over the past year </li></ul><ul><li>The sources or causes of change are important </li></ul><ul><li>Thus, a Statement of Owner’s Equity is needed for completeness </li></ul>
  20. 20. Changes in Owner’s Equity <ul><li>Last year’s Owner’s Equity </li></ul><ul><li>+ After-tax Income </li></ul><ul><li>- increase in current portion-deferred income tax </li></ul><ul><li>- Owner withdraws </li></ul><ul><li>+ Non-farm income </li></ul><ul><li>+ increase in market value of assets </li></ul><ul><li>- increase in noncurrent portion of deferred income taxes </li></ul>This Year’s Owner’s Equity