NEWS for North Dakotans
Agriculture Communication, North Dakota State University
7 Morrill Hall, Fargo, ND 58105-5665

December 23, 1998

[Editors note: this is the fourth article in the series: "Assessing Your Business For Today's Markets And Beyond."]

The Market Advisor: Sixty Percent of the Business Accounts Needed to Manage Are Found on Balance Sheet

Harlan Hughes, Extension Livestock Economist
NDSU Extension Service

A balance sheet or net worth statement contains 60 percent of the accounts needed in an effective farm or ranch business accounting system. It is the single-most-important financial statement of a farm or ranch business. Using a balance sheet with a farm earnings statement and a cash flow statement can help a farm or ranch manager better evaluate past business performance and plan for 1999 and beyond.

To manage through the tough times of 1999 and beyond, farmers and ranchers will need to have five basic accounts in their farm or ranch business accounting system: assets, liabilities, equity, revenue and expenses. The first three accounts, assets, liabilities, and equity, (60 percent) make up the balance sheet. This emphasizes the importance of a business balance sheet.

The next two basic accounts, revenue and expenses, are the two accounts that make up the earnings statement. The cash part of revenues and expenses is also found in the cash flow statement. These three financial statements, balance sheet, farm earnings statement, and cash flow statement, are the "big three" of any farm or ranch business accounting system. Trying to farm with out them is really asking for trouble.

The financial risks associated with today's thin profit margins are just too high to try to farm or ranch without business records. Many tried to farm in the 1980s without good business accounting records and it didn't work. They were let down by their on-farm or ranch business accounting records. Somehow, agriculture continues to circulate the myth that business and production records are not necessary for financial survival. The cost of this myth is that another set of farmers and ranchers will be let down in 1999 and beyond by their on-farm business records.

A good set of accounting records—consisting of a beginning and ending balance sheet, a farm earning statement, and a cash flow statementare an absolute must today. The balance sheet is sometimes called the net worth statement or financial statement. It shows the financial position of the business in terms of assets, liabilities, and equity. It is a summary of how funds are invested in the business (assets) and the financing methods (liabilities or equity capital) used. A balance sheet is a snap-shot of the business resources controlled on a given day.

A balance sheet is typically prepared on Jan. 1 (or the first business day) of each business year. Next year's first day balance sheet becomes this year's ending balance sheet. Used in conjunction with a farm earnings statement and a cash flow statement, the balance sheet plays a vital roll in helping a farm or ranch manager better understand his farm or ranch business.

Preparing a balance sheet consists of taking an inventory of all assets employed in your farm or ranch business on a given day and putting a dollar value on those assets. Two schemes are typically used to value assets, cost-basis and market-value-basis. Cost-basis is the remaining undepreciated value of assets. Market-value is the current market value of the assets as if they were sold that day.

Let's take a look at a summary of an example farm's market-based balance sheet for both the beginning the end of the business year. The current market value of all assets employed in this business were valued at $551,166. This total asset number is made up of current assets (assets that will be sold in one year or less) and non-current assets (those with a life greater than one year). The recently approved farm financial standards suggest that agriculture should start using the current asset and non-current asset categories used by other industries.

The example farm's liabilities totaled $356,060. Again, these should be broken down into the same current and non-current categories as were used for the assets. Assets minus liabilities equals net worth or equity. This example farm had $195,106 net worth or equity at the beginning of the year. The balance sheet for the end of year showed assets equaling $600,566 and liabilities at $363,119. Ending assets minus ending liabilities gives an ending net worth of $237,447.

One measure of financial progress is the change in equity over the year. This example farm gained $42,341 of equity during this yearquite good for these tough times. Most of equity gain was due to the $49,400 increase the value of assets at the end of the year. This increase was due to increased livestock being held for sale. Liabilities went up only $7,000 during the year.

An average column on my example farm's balance sheet represents the average of the beginning and ending values. Many farm or ranch management business measures are based on average investments and average liabilities. On average, $575,866 of assets are invested and controlled in this example business. Liabilities averaged $359,590 giving an average net worth of $216,276.

One key financial indicator for a farm or ranch business is the percent-in-debt. Percent-in-debt is calculated by dividing total liabilities by total assets and multiplying by 100. This example farm's percent-in-debt on the beginning balance sheet is 64 percent. This means that the farm family owns 36 percent of the business assets in this business and creditors own 64 percent of the business assets. The ending balance sheet shows 60 percent-in-debt with an average of the beginning and ending balance sheets showing 62 percent-in-debt.

Balance sheets can be used to measure the financial stress in the farm or ranch business based on the percent-in-debt. If the percent-in-debt is under 40 percent, the business is considered financially sound. If the percent-in-debt is greater than 40 percent but less than 70 percent, the business is considered to be financially vulnerable. If the percent-in-debt is greater than 70 percent, the business is considered under severe financial stress. If the percent-in-debt is above 100 percent, the business is considered financially insolvent. Based on this example farm's 62 percent-in-debt, this business is financially vulnerable and financial caution needs to be practiced.

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Source: Harlan Hughes (701) 231-7380 hhughes@ndsuext.nodak.edu

Editor: Tom Jirik (701) 231-9629

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