Preparing a Balance Sheet

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Preparing a Balance Sheet

  1. 1. Agriculture & Business Management Notes ... Preparing a Balance Sheet The financial distress was a consequence of a Quick Notes... number of factors which were in place during the 1970s, but reversed direction in the early All businesses (including agriculture) should 1980s. These factors include but are not prepare a balance sheet each year based on a limited to: recommended set of guidelines to insure uniformity of reporting. 1. Inflation (increasing land values primarily). A balance sheet or net worth statement is a 2. Favorable foreign exchange rates. summary of the assets and liabilities, and 3. Strong export market (strong owners equity (net worth) as of a specific international market). time. 4. Low "real" interest rates (negative real rate in 1974 and 1975). 5. Increased commodity supplies (capacity was expanded by The critical need for enhanced financial 20 percent in the 1970s). management skills and techniques in production agriculture became apparent in the The financial distress among farmers/ranchers 1980s. The decade of the 1980s, particularly and agricultural lenders was rooted in the the period 1981 through 1987, saw the inflationary decade of the 1970s, and financial position and conditions of many subsequent adjustments from that period to operations deteriorate. Many producers were sharply different economic conditions in the faced with insufficient cash flow, declining 1980s. Throughout the 1970s, farmers and asset values, rationing of capital by ranchers faced rapidly expanding exports, agricultural lenders, voluntary or forced accelerating inflation, and low to negative real liquidation, foreclosure (total or partial), and interest rates (the nominal interest rate minus bankruptcy. The stress of the financial the inflation rate). Farmers and ranchers situation was felt throughout the responded by borrowing heavily to invest in agricultural sector - including lenders, retail new equipment, adopt new production trade and the service sector. The technologies, and purchase increasingly financial stress was documented by loan expensive land. Farm debt rose an average of delinquencies and losses, inadequate securities more than 10 percent a year. Yet land values for loans, reduced business volume, and other rose even faster, providing the economic income flows within the rural/regional incentive for producers and lenders to expand economies. Colorado State University, U.S. Department of Agriculture and Colorado counties cooperating. Extension programs are available to all without discrimination. No endorsement of products is intended nor is criticism of products mentioned.
  2. 2. and roll over debt. Debt/asset ratios of farms Task Force declined over the 1970s. The following paragraphs, selected from the publication Recommendations of the Farm By the early 1980s, the factors that had given Financial Standards Task Force, clearly rise to the expansion had reversed direction. outline the need for standardization of Worldwide recession weakened international financial reporting in agriculture (2). Since markets; the value of the dollar rose rapidly this chapter adheres to the recommendations against major foreign currencies, further of this document, it is important that the dampening export demand; and inflation was background be established. slowed by stringent control of monetary growth. Real interest rates, which had been "During the decade of the 1980s, forces were low or negative throughout the 1970s, jumped set in motion that substantially changed the to unprecedented levels of 8 to 10 percent. methods of analyzing financial strengths and Agricultural commodities in foreign and providing credit to production agriculture. domestic markets were too plentiful to sustain Through most of that decade the farm the prices that had prevailed during the 1970s, financial industry was in turmoil caused by an causing commodity prices and producer unforeseen run-up in interest rates, record incomes to drop significantly. Land values, levels of farm debt, large fluctuations in farm which depend on both current farm income income, a rapid decline in the value of farm and prospects for future income growth, also assets, and insufficient or under-utilized begin to decline. The debt levels that some methods for analyzing the true profitability of producers had assumed over the 1970s were various farm enterprises. no longer sustainable. Agricultural operations whose solvency depended on continuously This environment created an increased interest rising land values or who pursued an in farm financial education and sophisticated aggressive expansion strategy were pushed financial analysis techniques. The demand toward insolvency. Moreover, even those brought about a rapid expansion in the number producers who pursued more cautious of products and services available for this financial strategies in the 1970s, but suffered analysis. Because each new system utilized from the 1980 or 1983 droughts or other its own specific method for analyzing farm natural disasters, faced financial stress for a operations, it was often difficult for different reason. agricultural producers, lenders, or farm financial experts to conduct comparative The need for enhanced financial management analysis between farming operations. skills and techniques became critical to many agricultural producers. Many efforts were The lack of standardization in farm financial undertaken in the public and private sector in analysis caused problems in understanding an attempt to fulfill this need. This need, and using data for decisions, and was often coupled with the growth and development of cited as a substantial barrier to the the micro computer, resulted in many products accessibility of funds from capital markets. that were helpful but often incompatible. In The magnitude of the problem was the following section, discussion related to the underscored when Congress passed the 1987 standardization of financial reporting and Agricultural Credit Act. During the debate on analysis and its evolvement through efforts of this legislation, experts testified that the lack the Farm Financial Standards Task Force of uniformity in analyzing farm operations (FFSTF) is presented. would prohibit the establishment of privatized secondary markets for agriculture. Thus, History of The Farm Financial Standards when the legislation was enacted, it contained 2
  3. 3. provisions for the government to sponsor a Statement of Cash Flows secondary market for agricultural real estate Statement of Owner Equity loans. Further, it is extremely important that the At the same time that Congress was working statements be prepared on a consistent basis, on the 1987 Agricultural Credit Act, the i.e. cover identical time periods. The task National Commission on Agricultural force did not develop specific formats for Finance, appointed by President Reagan, was these financial statements; only recommended examining the farm financial industry. This general guidelines to ensure uniformity of Commission cited a need for standardization reporting. As such, financial analyses (ratio of agricultural credit analysis and farm and comparative analyses) is more uniform. financial statements. Their report claimed The following is a brief description of each of that, without standardization nationwide, the the financial statements and the type of agricultural industry would have difficulty management decisions for which each of the learning how to analyze the financial strength statements can be used. of their operations, and agricultural producers would probably pay a premium for borrowed Balance Sheet funds as a result. In this section, the foundation of the balance sheet will be laid. The balance sheet can be Thus, the overwhelming evidence from all derived from the fundamental sectors seemed to indicate that agricultural accounting equation: producers, lenders, financial analysts, and agricultural economists could make better Assets = Owner's Liabilities + Owner Equity financial management decisions by uniformly OR Owner Equity = Assets - Liabilities defining the data, criteria, and measures that are most useful in addressing specific farm Traditionally, the balance sheet is arranged financial questions. In response to this issue, such that assets are listed on the left side and the Executive Committee of the Agricultural liabilities and owner's equity on the right side. Bankers Division of the American Bankers The balance sheet has historically been the Association (ABA) formed the Farm Financial primary (and often only) financial statement Standards Task Force (FFSTF)." used for agricultural lending. Until the events of 1980s demonstrated the necessity of more The following discussion provides an financial information for proper financial overview of the recommendations of the management, the balance sheet was relied FFSTF. The minimum set of financial upon as the means to evaluate potential statements are discussed as well as the borrowers. recommended financial measures of performance analysis. Each financial The balance sheet must balance, hence the statement is presented and discussed briefly. name balance sheet--total assets equal to total It is recommended that the reader acquire a liabilities and net worth (owner equity). copy of the FFSTF recommendations to gain further detail. What items fall under each of these categories? The following definitions aid in The minimum set of financial statements classifying both assets and liabilities. recommended by the FFSTF include: Current assets: Items that are held for sale, Balance Sheet cash on hand, savings, inventory of products Income Statement 3
  4. 4. that could be sold, and financial instruments improvements). Working assets include that are readily convertible to cash (e.g., machinery, equipment and breeding stock. shares in IBM). Others include stock in Farm Credit Services or other similar entities that have value but are Current liabilities: Items that are due and not readily marketable. Often life insurance must be paid within the next year. This would policies with cash value are placed in this include outstanding feed, fertilizer, wages, category. Recreational and personal assets fuel bills, etc. Also included are accrued may or may not be listed. interest and principal payments on operating notes, machinery, livestock loans, real estate Non-current liabilities: Account for the mortgage payments and lease payments due loans for machinery, equipment, livestock or during the next year. real estate and other financial obligations that have a term greater, than one year. Thus, any Non-current assets: Tend to be the working liabilities that have been amortized for more assets and real estate (including buildings and than one year would be listed in this section. The balance sheet is structured as follows: Assets Liabilities Current: ________ Current: ________ Non-Current: ________ Intermediate: ________ Net Worth: ________ Total Liabilities Total Assets: ________ and Net Worth: Balance sheets are normally prepared for separate entities even in a sole proprietorship. GAAP guidelines in traditional accounting support that the business be reported separately from its owner. The exception is agriculture where producers and lenders prefer a consolidated or combined statement. A combined statement includes both personal and business assets and liabilities. Notes... (For More Information) Contact: Norm Dalsted, Dept. of Ag. & Resource Economics, Network CSU, (970) 491-5627 Norman.Dalsted@colostate.edu (Updated August 2008) 4

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