Strategic Business Planning for Commercial Producers Financial Documentation Basics: How Do I get...

Strategic Business Planning for Commercial Producers

Financial Documentation Basics: How Do I get Started?


Objectives

• Understand the basics of accurately measuring financial performance (profitability)

• Explore issues that affect the completeness and accuracy of financial statement information

• Examine the impact of these issues on financial performance measures


Basic Financial Statements Balance Sheet (beginning and ending)

Assets, liabilities & equity

Income StatementRevenue, expenses and profit

Statement of Owner EquitySources of change in equity

Statement of Cash FlowsSources of change in cash

STATEMENT OF CASH FLOWS

Inflows of cash minus outflows of cash (change in each balance sheet account from the beginning to the end of the accounting period to determine how those changes affected the cash account)

PLUS EQUALS

End of Year

BALANCE SHEET

Assets

Liabilities

Equity

Beginning of Year

BALANCE SHEET

Assets

Liabilities

Equity

PLUSINCOME

STATEMENT

Revenues and gains minus

expenses and losses

STATEMENT OF OWNER EQUITY

Change in equityOwner contributions, retained earnings, &

valuation

EQUALS


What Entity?• Entity Concept: business accounts are kept for

business entities rather than the persons who own and operate them.

• Personal financial information can be reported in a personal financial statement called a Statement of Financial Condition.

• Personal financial information must be separated from business information.


Entities

Farm BusinessContributions

OwnersW

ithdrawals


Measuring Net Income - Accrual Versus CashAccrual financial reporting:

recognizing income on the income statement in the period it is earned and expenses in the period in which they are incurred.

versus

Cash accounting: accounting for cash receipts when received and cash expenditures when paid.

End of Year

BALANCE SHEET

Assets Current $485,376 Noncurrent $4,170,100

Liabilities Current $321,867 Term $799,572

Equity $3,534,037

Beginning of Year

BALANCE SHEET



Equity $3,285,991

Precise classification of assets and liabilities is important!


Types of Accrual Adjustments

• Current assets excluding cashExamples: accounts receivable, grain/feed inventories, market livestock, supplies & prepaid expenses, investments in growing crops

• Farm accounts payable• Accrued interest• Other accrued expenses


Accrual Adjustments - Noncurrent Assets

• Depreciation expense is an accrual adjustment typically associated with noncurrent section of the balance sheet.

• Gains or losses on noncurrent assets that are an ordinary and necessary part of production activities (sales of cull cows/sows) are included in net income from operations.

• Gains or losses on noncurrent assets that are nonrecurring are included in net income but not net income from operations.

End of Year

BALANCE SHEET

Assets

Liabilities

Equity

Beginning of Year

BALANCE SHEET

Assets

Liabilities

EquitySTATEMENT OF CASH FLOWS

BEGINNING CASH $157,689Operating activities Net cash income $52,421 - Cash withdrawals $150,000

-$97,579Investing activities Capital sales $63,800 - Capital purchases $97,895

-$34,095Financing activities New borrowing $150,000 - Principal payments $170,999

-$20,999ENDING CASH $5,016

MBC Farms Income Statement

Revenue

Cash sales & govt. Payments

$1,432,549

Breeding Stock $63,800

Change in:

Inventory $38,015

Accounts receivable $77,140

Prepaid expenses $185,147

Gross revenue $1,796,651

Expenses

Cash $1,517,050

Change in:

Accounts payable $1,962

Accrued interest -$2,880

Operating Expense $1,516,132

Net Farm Income from Operations $280,519


Cost or Market Values?

How should farm business assets be valued on the farm balance sheet?

A. MarketB. CostC. Both


General AdvantagesMarket Values

• Easy to derive• More comparable

across farms• Benchmark data

readily available• Better measure of

opportunity cost • Required by

lenders

Cost Values• More accurate

measure of actual performance of invested capital

• Better measure of financial progress over time

• Critical for determining the sources of equity change in the business


Ratio Comparison

MBC Farms at: Market CostOperating Profit Margin

12.8% 12.8%

Asset Turnover 38.6% 74.6%

Return on Assets 4.9% 9.5%

Return on Equity 3.7% 10.1%

Debt to Asset Ratio 24.1% 46.6%

Current Ratio $1.51:1 $1.51:1


What are the sources of equity?

• Paid-in capital/Contributed capital– Contributions of equity from owners

• Retained earnings– Business generated net income less

withdrawals from the business

• Valuation equity– Excess of the market values of noncurrent

assets over their cost values (investment less depreciation)

– Valuation equity is unearned and may never be realized

End of Year

BALANCE SHEET



Equity $3,534,037

Beginning of Year

BALANCE SHEET



Equity $3,285,991

MBC Farms – Market Value Balance Sheets

Ending owner’s equity $3,534,037Minus beginning owner’s equity $3,285,991Equals increase in owner’s equity $ 248,046

The source may be as important as the amount!


Valuation Equity: MBC Farms

Beginning Balance Sheet

Ending Balance Sheet

Noncurrent Assets

Cost MarketValuation Equity

Cost MarketValuation Equity

Breeding Livestock

0 175,000 175,000 0 181,250 181,250

Machinery 155,326 376,850 221,524 155,564 339,165 183,601

Land 1,551,330

3,108,5031,557,17

31,551,3

303,240,000

1,688,670

Buildings 255,793 431,247 175,454 216,529 409,685 193,156

Totals 1,962,449

4,091,6002,129,15

11,923,4

234,170,100

2,246,677

Increase in valuation equity = (2,246,677– 2,129,151) = $117,526

Beginning of Year

BALANCE SHEET

Assets $4,429,347

Liabilities $1,143,356

Equity Contributed Cap $ 0 Retained Earnings $1,156,840 Valuation Equity $2,129,151Total Owner’s Equity$3,285,991

End of Year

BALANCE SHEET

Assets $ 4,655,476

Liabilities $ 1,121,439

Equity Contributed Cap $ 0 Retained Earnings $1,298,359 Valuation Equity $2,246,677Total Owner’s Equity $3,534,036

Statement of Changes in Owner’s Equity Increase in contributed capital $ 0 Increase in retained earnings $ 130,519 Increase in valuation equity $ 117,526 Total change in equity $ 248,045


Key Points?1. Make accrual adjustments to

accurately measure profitability and financial position

2. Cost and market value based measures are each useful in their own ways: market for benchmarking,

creditworthiness cost for trend analysis, performance of

invested capital, and evaluating leverage

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