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 Statement Revenue, expenses and profit Statement of Owner Equity Sources of change in equity Statement of Cash Flows Sources 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 PLUS INCOME STATEMENT Revenues and gains minus expenses and losses STATEMENT OF OWNER EQUITY Change in equity Owner 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 Business Contributions Owners Withdrawals

Measuring Net Income - Accrual Versus Cash Accrual 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 Assets Current $337,747 Noncurrent$4,091,600 Liabilities Current$252,136 Term$891,220 Equity$3,285,991 Precise classification of assets and liabilities is important!

Types of Accrual Adjustments Current assets excluding cash Examples: 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 Equity STATEMENT OF CASH FLOWS BEGINNING CASH$157,689 Operating activities Net cash income$52,421 - Cash withdrawals$150,000 -$97,579 Investing activities Capital sales$63,800 - Capital purchases$97,895 -$34,095 Financing activities New borrowing$150,000 - Principal payments$170,999 -$20,999 ENDING 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. Market B. Cost C. Both

General Advantages Market 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:MarketCost Operating Profit Margin12.8% Asset Turnover38.6%74.6% Return on Assets4.9%9.5% Return on Equity3.7%10.1% Debt to Asset Ratio24.1%46.6% Current Ratio$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 Assets Current$485,376 Noncurrent$4,170,100 Liabilities Current$321,867 Term$799,572 Equity$3,534,037 Beginning of Year BALANCE SHEET Assets Current $337,747 Noncurrent$4,091,600 Liabilities Current$252,136 Term$891,220 Equity$3,285,991 MBC Farms – Market Value Balance Sheets Ending owner’s equity $3,534,037 Minus beginning owner’s equity $3,285,991 Equals increase in owner’s equity$ 248,046 The source may be as important as the amount!

Valuation Equity: MBC Farms Beginning Balance SheetEnding Balance Sheet Noncurrent Assets CostMarket Valuation Equity CostMarket Valuatio n Equity Breeding Livestock 0175, ,250 Machinery 155,326376,850221,524155,564339,165183,601 Land 1,551,33 0 3,108,5031,557,173 1,551,33 0 3,240,000 1,688,67 0 Buildings 255,793431,247175,454216,529409,685193,156 Totals 1,962,44 9 4,091,6002,129,151 1,923,42 3 4,170,100 2,246,67 7 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$2,129,151 Total 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$2,246,677 Total 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

Strategic Business Planning for Commercial Producers