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BUSINESS TOOLS
Preparing Agricultural Financial
Statements
Thoroughly understanding your business’ financial performance is critical for success
in today’s competitive agricultural, forestry and fisheries environments. Accurate
records and financial statements are the foundation needed to analyze the financial
condition and trends of your operation. All agricultural businesses, from small part-
time farms to large commercial operations, require updated financial statements on a
regular basis to track financial progress.
How do financial statements prove useful?
As a tool for management
Successful managers use financial statements in combination with production records to identify
strengths and weaknesses in their operation. In addition to tracking trends in assets and liabilities,
financial statements can reveal where revenues are originating and where expenses are occurring.
Financial statements can be used to time cash expenditures and plan for credit needs. Finally, these
statements provide the critical data for ratio analysis and benchmarking.
As a tool for use with lenders and other professionals
Lenders request, and in most cases require, an accurate set of financial statements to accompany
a credit request. A carefully prepared set of financial statements shows you have a detailed
understanding of your business and its repayment capacity. Others, such as attorneys and financial
planners, also need financial statements for services such as estate and retirement planning,
organizational establishment and buy-sell agreements for business transition purposes.
Tip: Take time to review
year-end statements prepared by your accountant to better understand the true financial position of your business.
TOOLS
Preparing Agricultural Financial Statements
As a tool for tax compliance
A carefully prepared set of financial statements can
make life much easier when tax time comes around.
This prevents last minute information collection and
provides peace of mind in an IRS audit. Financial
statements can be prepared by individuals, in-
house employees or accountants. Statements
prepared by accountants will range from simply
compiling a business owner’s numbers, to reviewing
and reconciling numbers, to a formal, unqualified
audit. Even if you have an accountant that keeps
your operation’s books and prepares your taxes,
it’s still important to understand how financial
statements are prepared. Although accountants are
professionals and are knowledgeable in their field,
no one understands your business like you do.
Financial statements include the balance sheet,
income statement, statement of owner equity,
statement of cash flows and cash flow projection.
Our discussion will focus on the three most
commonly used financial statements: the balance
sheet, income statement and cash flow projection.
Financial statements are interrelated; therefore,
proper timing of the statements is important to gain
the most benefit.
Balance sheet
The balance sheet is a statement of financial
position at a specific point in time or a financial
snapshot of the business. The balance sheet
reflects the result of all past transactions but not
how the current financial position was obtained.
The balance sheet consists of three main parts:
Assets
Assets include anything that is owned by the
entity that has monetary value. Standard
accounting practices value assets at either cost,
market value or the lower of the cost or market,
depending on what is preferred by the person
preparing or requesting the balance sheet. Assets
valued on a cost basis are listed at the historical
cost less any accumulated depreciation. Market
valued assets are listed at fair market value
based on the asset’s condition, location or other
relevant factors. Assets should be separated into
two categories: current and non-current. A more
detailed discussion of asset classification will
follow.
Liabilities
Liabilities include all claims against the business
by creditors, suppliers or any other person or
institution to which a debt is owed. Liabilities, like
assets, are classified into current and non-current
categories.
The basis for the balance sheet is the
fundamental accounting equation:
This equation shows the total assets of a
businessthat were acquired with a combination of
funds from claimholders and owners.
Assets = Liabilities + Owner Equity
Tip: All ag businesses
require regular financial
statements to track progress.
TOOLS
Preparing Agricultural Financial Statements
Liabilities
Similar to assets, liabilities are also classified as
either current or non-current. The liability section
of the balance sheet should include all obligations
(classified based on repayment schedule) as of the
date of the balance sheet.
Current liabilities
All debts and obligations that are due within the
next 12 months. Examples of some common
current liabilities are:
- Accounts Payable - Money owed to
suppliers or other businesses for products or
services the business has received but not
yet made payment for.
- Operating loans - Any outstanding balances
on revolving or non-revolving operating lines
of credit. It’s common in agriculture for loans
to be financed for one year with the option of
renewal at the end of the year given accept-
able repayment performance. If the lender is
under no obligation to renew the loan at the
end of the original agreement, the liability
should be classified as a current liability.
- Principal portion of term loans due within
the next year - The total amount of principal
on term loans that is due to be paid within
the year.
- Accrued interest - The amount of interest
that has accrued on all loans. This is the
total amount of interest that would be due
if all loans were paid off as of the day of the
balance sheet – it is not the total amount
of interest due to be paid in the next 12
months.
- Accrued income and property taxes -
Property taxes are typically paid in a period
following when they are incurred, and
income taxes are paid as frequent as every
quarter, so the balance sheet will often
reflect some accrued tax liability.
- Other accrued expenses - Items such
as rents and leases that have been
utilized but not yet paid would be accrued
expenses.
- Credit card debt - Credit card debt,
including principal and interest, is included
as a current liability.
Non-current liabilities
Non-current liabilities capture all obligations that
are due and payable beyond one year. The most
common non-current liabilities are term loans
used to finance machinery, equipment, breeding
livestock or real estate. The portion of the term
loan due beyond 12 months is considered a non-
current liability. Remember the principal amount
due within 12 months is a current liability.
Contingent liabilities
Another category of liabilities is contingent
liabilities, which includes such items as
guarantees, pending lawsuits, and federal and
state tax disputes. Common contingent liabilities
also include student loans or car loans co-signed
by parents. These items appear as footnotes to
the balance sheet and are not liabilities at the
present, but the potential for an obligation exists.
Tip: One problem encountered by some
producers is balancing
their debt terms with repayment capacity.
TOOLS
Preparing Agricultural Financial Statements
Owner Equity
Owner equity is a residual amount after liabilities
are subtracted from assets (see Exhibit 1 below
and Exhibit 2 on the next page). Owner equity
reflects the owner’s investment of capital into
the business and retained earnings which are
generated over time. Retained earnings are profits
that have been reinvested back into the business
rather than withdrawn by the owners or paid out in
dividends in the case of a corporation.
Balance sheet considerations
The ownership structure of agricultural business-
es is becoming increasingly complex. The tradi-
tional sole proprietorship is no longer the norm
in agriculture. Combinations of partnerships,
corporations and limited liability companies are
quickly emerging with one entity holding operat-
ing assets and another entity controlling the cap-
ital assets. It is essential to identify the entity for
which the balance sheet is being prepared, such
as business, personal or a consolidation of both.
Cost Market
Value
Current Assets
Cash $6,750 $6, Marketable Securities 2,500 5, Accounts Receivable 600 600 Livestock Held for Sale 48,500 48, Crops and Feed 61,500 61, Cash Investment in Crops 1,200 1, Supplies 1,300 1, Prepaid Expenses 500 500 Total Current Assets $122,850 $125,
Non-Current Assets
Machinery and Equipment – $85, Cost $110.500 – – Acc. Depreciation 40,000 $70,500 – Breeding Livestock 22,500 22, Retirement Accounts 6,500 6, Cash Value of Life Insurance 8,100 8, Securities Not Readily Marketable 4,600 4, Personal and Recreational Vehicles 13,100 13, Household Goods and Personal Items 8,000 8, Farm Real Estate and Buildings – $495, Cost $380,000 – – Acc. Depreciation 40,000 $340,000 – Total Non-Current Assets $473,300 $643,
Total Assets $596,150 $769,
Cost Market
Value
Current Liabilities
Accounts Payable $3,500 $3, Operating Loan 45,000 45, Principal Portion of Term-Debt Due Within One Year 34,000 34, Accrued Interest 10,500 10, Estimated Accrued Taxes 8,600 8, Accrued Rents Payable 1,300 8, Deferred Tax Liability on Current Assets – 32, Total Current Liabilities $102,900 $142,
Non-Current Liabilities
Machinery Loans $29,000 $46, Real Estate and Building Loans 175,000 175, Deferred Tax and Liabilities on Non-Current Assets – 23, Total Non-Current Liabilities $204,000 $244,
Total Liabilities $306,900 $386, Owner Equity 289,250 382,
Total Liabilities and Owner Equity $596,150 $769,
Exhibit 1 / Balance Sheet — Beginning of Year
TOOLS
Preparing Agricultural Financial Statements
Often a person is involved in more than one
business venture. If so, information about assets
and liabilities associated with other businesses
should be identified. One business may show
significant equity while another is heavily leveraged.
Lenders are likely to request a consolidated balance
sheet that combines all business and personal
assets and liabilities.
Valuing leases
Numerous valuation issues arise when preparing
balance sheets which exceed the scope of this
discussion. One issue is that of capital leases
for items such as tractors, combines, irrigation
equipment and storage structures. In the past, many
lease obligations were simply included as footnotes
to the balance sheet. However, these types of leases
should be included on the balance sheet.
There are two genera types of leases: operating
leases and capital leases. Operating leases allow the
lessee the right to use an asset for a relatively short
period of time. Most operating leases should appear
as a note to the balance sheet (unless prepaid or
past due), similar to the rental of farm land. A capital
lease is a direct substitute for purchase of the asset
with borrowed money. It transfers substantially all
the benefits and risks inherent in the ownership of
the property to the lessee.
Exhibit 3 illustrates an example of a five-year capital
lease agreement with annual payments (due at
the beginning of the period) of $11,991. The lease
is treated similar to an equal payment, amortized
loan and must be reflected as both an asset and a
liability on the balance sheet. Although there is no
interest rate stated in the agreement, an $11,
annual payment for five years at an “imputed
interest rate” of 10% results in a present value of
$50,000. This is the initial lease value (both asset
and liability). Remember, it’s the lease investment
which is being put on the balance sheet, not the
asset being leased.
Also in Exhibit 3, the asset is listed as a non-
current asset each year. The principal due within
the year and any accrued interest as of the date of
the statement are listed as current liabilities, and
the remaining lease obligation is a non-current
liability.
Deferred taxes
As discussed earlier, assets can be valued on the
balance sheet, either on a cost or market value
basis. A market value balance sheet reflects the
impact of deferred tax liabilities (refer back to
Exhibits 1 and 2). Deferred taxes are the federal
and state taxes that would be incurred if the
business was liquidated. Deferred taxes on
current assets arise because many agricultural
producers report income on a cash rather than
accrual basis for income tax purposes. Therefore,
they do not pay taxes on the accumulation of crop
and livestock inventories over time. Income taxes
would be due if inventories were sold and if the
expenses associated with them had previously
been deducted as cash expenses. Deferred taxes
may also be present on non-current assets. Two
examples of deferred tax situations are:
- Market value of assets exceeds cost less
accumulated depreciation.
- Sales price of purchased breeding livestock
exceeds the original cost.
Tip: Capital leases
should be included on
the balance sheet.
TOOLS
Preparing Agricultural Financial Statements
Income statement
A business income statement, also called a profit
and loss statement, is used to measure revenues
and expenses over an accounting period. Unlike the
balance sheet, which reflects the financial position
at a single point in time, the income statement
shows income and expenses for a period of time,
usually one year. Income statements can be used
to determine income tax payments, analyze a
business’ expansion potential, evaluate profitability
and assist in loan repayment analysis.
Identifying the entity
Identifying the business entity is also important
when preparing an income statement. The income
statement should be prepared for the same entity
as the balance sheet, either business, personal
or consolidated. Because of the interrelationship
between the balance sheet and income statement,
the time period covered by the income statement
should be the time between the beginning and
ending balance sheets. The most common period is
annually, although quarterly or monthly statements
are sometimes desired.
Revenues and expenses
All income statements include two categories:
revenues and expenses. However, income
statements can be prepared two ways, depending
on how revenues and expenses are derived. A
cash income statement measures revenues only
when received and expenses only when paid. An
accrual income statement measures revenues
when generated and expenses when incurred,
whether or not cash actually changes hands. The
cash income statement (illustrated in Exhibit 4)
is the easiest to prepare but is inadequate for
measuring true profitability because it fails to
match the timing of income and expenses.
Depreciation
Depreciation, although not a cash expense, is
included on both the cash and accrual income
statements as a way of spreading the cost
of capital purchases over their useful life.
Accelerated depreciation is frequently used for
tax purposes. If this is the case, it should be noted
that accelerated depreciation is being used,
because it could distort profitability.
Tip: A balance sheet provides a financial snapshot of the business at any given time. An
income statement shows
income and expenses for a period of time, usually one year.
Exhibit 3 / Balance Sheet Presentation of Capital Leases
Beginning of Period (1)
Non-Current Assets Year 1 Year 2 Year 3 Year 4 Year 5
Capital Leased Asset (initial lease value) $50,000 $50,000 $50,000 $50,000 $50, Less: Accumulated Depreciation (8,190) (17,199) (27,108) (38,009) (50,000) 41,810 32,801 22,892 11,991 –
Current Liabilities
Current Portion of Capital Leases (1) $9,009 $9,909 $10,901 $11,991 –
Non-Current Liabilities
Non-Current Portion of Capital Leases $32,801 $22,892 $11,991 – – Total Capital Lease Liabilities $41,810 $32,801 $22,892 $11,991 –
Initial Lease Value: $50, Annual Lease Payment: $11, (Beginning of Period)
Imputed Borrowing Rate: 10% Lease Term: 5 Years
Annual Depreciation = Principal Reductions
Tip: A University of Illinois study found that the difference between cash and accrual income averages 31 percent.
TOOLS
Preparing Agricultural Financial Statements
Expense items included on the income statement
vary with the type of business but include all
operating expenses, interest and depreciation.
Cash flow projection
The balance sheet and income statement provide
present and historical financial information that
reflect past financial performance of a business.
However, producers and lenders are often equally,
if not more, interested in future performance. For
this reason, a cash flow projection is a valuable
financial tool.
A cash flow projection summarizes cash inflows
and outflows over a given period. A projection
can be prepared for the business, individual or
a consolidation of both, similar to the balance
sheet and income statement. The cash flow
projection can be useful for preparing projected
income statements and balance sheets and for
determining:
- The need for operating lines of credit to
cover cash flow deficits.
- Periods of excess cash when funds could
be placed in income-earning assets such
as money markets or the Future Payment
Fund offered by Northwest Farm Credit
Services.
- The need for changes in marketing or
expenditure plans.
- The cash flow feasibility of a new
investment.
- The cash flow in a transition year before
the operation is fully engaged.
Exhibit 5 / Accrual – Adjusted Income Worksheet
Net Cash Farm Income $49,
Gain/Loss from the sale of culled breeding livestock (purchased and raised) +/- (1,400) Change in value due to change in quantity of raised breeding livestock +/- – Increase in inventory (crop and livestock) + 12, Decrease in inventory (crop and livestock) - – Increase in accounts receivable + 300 Decrease in accounts receivable - – Increase in investment in crops + 250 Decrease in investment in crops - – Increase in supplies + – Decrease in supplies - (700) Increase in prepaid expenses + – Decrease in prepaid expenses - (150) Decrease in accrued expense (including interest, taxes, and rents) + 900 Increase in accrued expense - – Decrease in accounts payable + – Increase in accounts payable - (1,800)
Accrual Adjusted Net Farm Income From Operations (sum of above) $59,
Gain/Loss on the sale of farm capital assets (except culled breeding livestock) +/- – Gain/Loss due to change in general base values of breeding livestock +/- 4,
Accrual Adjusted Net Farm Income $63,
Parentheses indicate items that reduce net farm income and should be subtracted when calculating accrual-adjusted net farm income. Source: Freddie Barnard, Agricultural Economics, Purdue University; David M. Kohl, Agricultural and Applied Economics, Virginia Tech.
TOOLS
Preparing Agricultural Financial Statements
Components
While cash flow statement formats can vary, there
are three basic components: cash inflows, cash
outflows and operating finance activities.
Exhibit 6 illustrates a cash flow projection. Cash
inflows include receipts from farm and nonfarm
activities that are divided into relevant categories for
the type of business being examined. Cash outflows
include a detailed listing of cash expenses as well as
principal and interest payments on term debt.
Note depreciation does not appear on the cash flow
projection because it’s not a cash expense and will
not impact cash flow. The operating finance activities
section outlines the net cash flows for each quarter
along with the short-term borrowing needs, interest
accrued and repayment of the line of credit.
Different scenarios
A one-year projection can be completed for different
scenarios to examine price, cost and related impacts.
Cash flow projections for multiple years may also
be useful when development is being done, in order
to project cash needs prior to full production or
adequate production to break even.
Different cash flow scenarios may include: “How
would cash flow be affected if commodity prices
were 50 cents lower than expected?” or “What is
the impact of a 10% increase in fertilizer costs?”
Testing these options helps identify how sensitive
an operation or projected scenario is to changes
in the market environment. It’s important to
remember a cash flow projection is only as good
as the assumptions and information used to
prepare it.
Whether you are preparing your own statements,
or analyzing those prepared by an accountant,
this publication should provide a good basic
understanding of how to prepare financial
statements that are valuable both internally as
a management tool, and externally for use with
outside professionals.
Cash flow statements are prepared as follows:
Beginning Cash Balance + Cash Inflows
- Cash Outflows = Ending Cash Balance
Tip: It’s important to remember, a cash flow
projection is only as good
as the information and assumptions used to prepare it.
