Tools of Farm Business Analysis
Included in the list are budgets, the balance sheet, the income statement (profit and loss statement), and the cash flow summary.
A budget is an estimate of the revenue, costs, and net income of a farm unit or an enterprise. Development of a budget helps the farm manager to organize information into a logical order. Income and expense items otherwise overlooked are often exposed through development of a budget.
The budgeting process is extremely helpful when visiting a lender, both because of the information available from budgets and due to the "businesslike" image created for the person who offers budgets to support a loan request. Lenders have more confidence in a prospective borrower who organizes and plans - both characteristics are reflected in a budget.
The budget provides detailed listings of sources and amount of income and expenses. It indicates the amount of inputs required for the enterprise, such as quantities of grain, silage, hay, and other feed components. Costs are divided into variable (cash) costs and fixed (overhead) costs. Finally, the budget reflects returns above both variable and total costs.
Different names are used to describe the document here called a "balance sheet." It is often called a financial statement and sometimes a net worth statement. The term "balance sheet" implies some kind of balance as part of the document. The balance relates to the relationship between assets on one side of the document and liabilities on the other side That balance results in the basic accounting equation which states that assets always equal liabilities plus owner equity.
Balance sheets may reflect both business and personal assets and liabilities or only business or only personal assets and liabilities. If both business and personal assets and liabilities are included, the result is a consolidated balance sheet. If only business assets and liabilities are included, the document is a business balance sheet. If the document includes only personal assets and liabilities, it is a personal balance sheet.
The balance sheet provides a "snapshot" of a business' financial position at a specific point in time. It is one of the most basic tools used in financial management and should be developed on an annual basis by every farm manager. By comparing end-of-year balance sheets from consecutive years, the manager can determine changes that are occurring in the various types of assets and liabilities. Changes in net worth, through time, can also be determined by comparison of balance sheets from several years.
A number of definitions are in order before proceeding with a discussion of using the balance sheet in farm business analysis. An asset is something having economic value that is controlled by an individual or firm. Assets include cash, personal property convertible to cash given sufficient time, and real estate. The length of time required to change the item to cash determines the type of asset. The types of assets are current, intermediate, and long-term.
Current assets are those which impact the business within one year. Current assets include cash, accounts or securities easily converted to cash, and commodities that will produce cash within twelve months. Inventory items (feed, fertilizer, fuel) and livestock raised for sale are current assets.
Intermediate-term assets are those items which are expected to impact the business after one year but within ten years. This category includes assets used in production of income. Machinery and equipment, breeding livestock, retirement accounts, and longer-term securities are classified as intermediate assets.
Long-term assets are primarily related to real estate. Land and improvements are the usual long-term assets.
Liabilities are the financial obligations incurred by an individual or firm. They are composed of current, intermediate, and long-term obligations.
Current liabilities are those which impact the business within one year. They include bills or accounts due with one year. Income tax, FICA or self-employment tax, real-estate tax, and notes are included in this category. Principal payments on longer-term debts and interest due within one year are also part of current liabilities.
Intermediate-term liabilities are those items which are expected to impact the business after one year but within ten years. They include debts due after one year but within ten years. Loans used to purchase machinery or equipment and breeding livestock are usually classified as intermediate.
Long-term liabilities are related to real estate and typically involve debts due after more than ten years from the initial date of the loan. Real estate mortgages are the typical obligation that appears on the balance sheet as a long-term liability.
Net worth is computed by subtracting total liabilities from total assets. Net worth reflects a position at a point in time and will differ day to day or year to year.
There is no standard form for the balance sheet. However, there is a degree of uniformity among these documents. Regardless of the source, a balance sheet will include current assets and liabilities, intermediate assets and liabilities, long-term assets and liabilities, and net worth.