Financial Statements Annie’s Project January 30, 2007 Coweta Oklahoma
What are financial statements? Financial statements are the written reports on the financial condition of a business. There are three major types of financial statements.
Types of Financial Statements • Balance Sheet A statement that shows the wealth of the business at a given date. • Cash Flow Statement A summary of the cash inflows and outflows for a business over a given time period. • Income Statement A summary of income and expenses for a business over a given time period.
Balance Sheet • A balance sheet is a summary sheet of everything that is owned and owed by the operation. • A balance sheet should be done at the beginning and end of each fiscal time period. • A balance sheet can be done using the market value or cost basis methods.
Which Method to Use? • Market Value • Typically used by most lending institutions • Easiest to determine • Easiest to over or under estimate • Due to rapidly changing markets, could overstate or understate net worth. • Cost Basis • Must have good records • Must know depreciation of assets • Probably gives a truer picture of the value of the business
Parts of a Balance Sheet A balance sheet has three components • Assets – what is owned Current and non-current • Liabilities – what is owed Current and non-current • Net Worth – Assets minus Liabilities
Current Assets Current assets are assets that will be used up or sold during the next twelve months. Examples include: • Cash, checking accounts, savings • Investments • Accounts receivable • Prepaid expenses • Cash investments in growing crops • Inventories • Market livestock, stored crops, purchased feed, supplies
Non-Current Assets Non-current assets are assets that have a useful life of more than 1 year. Examples include: • Breeding livestock • Machinery, equipment • Vehicles • Investments in capital leases • Land • Buildings and improvements
Current Liabilities • Accounts payable • Notes payable • Current portion of term debt • Accrued interest • Taxes payable • Deferred taxes
Non-current Liabilities • Notes payable, non-real estate • Notes payable, real estate • Deferred taxes
Net Worth • Net worth of the business is the difference between the total value of the assets and the total value of the liabilities. Net (Current Assets + Non-current Assets) Worth − (Current Liabilities + Non-current Liabilities) =
Cash Inflows Operating receipts Crop and livestock sales, government payments, other farm income Capital sales Contributed capital Cash Outflows Operating expenses (feed, fertilizer, etc.) Capital purchases Family living and other withdrawals Cash Flow Statement A cash flow statement is a summary of cash inflows and outflows divided into equal time periods usually monthly.
Uses of a Cash Flow Statement • Establishes target levels for income and expenses which can be used in monitoring progress towards goals • Points out potential problems in meeting financial obligations • Indicates when cash is available for new investments
Income Statement There are two methods of doing an income statement. • Cash • Cash receipts and expenses are recorded when the they are paid. • Most non-cash expenses are not included. • Accrual • Records receipts and expenses when they occur. • Inventory changes are included.
Difference Between Cash Flow and Income Statement Income statement does not include: • Capital sales and contributed capital • Principal payments • Family living expenses Cash flow statement does not include: • Depreciation
The Accrual Adjusted Income Statement • Revenues • Livestock and crop sales • Changes in inventories • Government payments & other farm income • Gain/loss from sale of culled breeding stock • Change in value due to change in raised breeding livestock numbers • Accrual adjustments in asset accounts
Changes in Inventories • Market livestock • Raised crops/feed inventories
Gains/Losses on Sale of Culled Breeding Livestock • Purchased breeding stock: subtract cost basis from the sale proceeds • Raised breeding stock: subtract base value from the sale proceeds
Change in Value Due to Change in Raised Breeding Livestock Numbers • Number of head transferring from one classification to another, e.g., replacement heifers to cows • Differences in base values of the two classifications
Accrual Adjustments (Assets) Change in: • Accounts receivable • Prepaid expenses • Cash investment in growing crops • Supplies • Contracts and notes receivable • Investment in cooperatives
The Accrual Adjusted Income Statement • Expenses • Purchased market livestock • Cash operating expenses • Changes in feed inventories • Accrual adjustments for liability accounts • Depreciation • Cash interest paid • Change in accrued interest
Accrual Adjustments Changes in: • Purchased feed inventories • Accounts payable • Ad valorem taxes • Employee payroll withholdings • Accrued expenses • Accrued interest
Depreciation There are different methods of depreciation. • Modified Accelerated Cost Recovery System (MACRS) • General Depreciation System (GDS) • Alternative Depreciation System (ADS) • Which one depends type of property • Straight Line Depreciation Cost – Salvage Value Years of Life
The Accrual Adjusted Income Statement • Net Farm Income, Accrual Adjusted = Gross Farm Revenues - Total Operating Expenses - Total Interest Expense +/- Gain/Loss on Sale of Farm Capital Assets
Gains/Losses on Sale of Farm Capital Assets • Difference between the value for which the items is sold and the adjusted basis (cost minus depreciation taken)
Measuring Financial Stress • Liquidity • Ability to pay bills as they come due and cover unanticipated events • Solvency • Ability to cover all debts if the business were sold • Profitability • Returns to labor and management generated by the operation • Financial efficiency • Efficiency with which assets generate income • Repayment capacity • Ability to repay term debt in a timely fashion
Measuring Liquidity Current ratio = Total current farm assets Total current farm liabilities Low Stress High Stress
Measuring Solvency Debt/asset ratio = Total farm liabilities Total farm assets Low Stress High Stress
Measuring Profitability Net Farm Income = Gross farm revenue - all farm operating expenses incurred to create those revenues +/- gains/losses on sale of capital assets Low Stress High Stress
Measuring Profitability Rate of Return on Farm Assets = (Net farm income from operations + farm interest expense - value of unpaid labor & management) (Average total farm assets) Low Stress High Stress
Measuring Profitability Rate of Return on Farm Equity = (Net farm income from operations - value of unpaid labor & management) (Average total farm equity) Low Stress High Stress
Measuring Efficiency and Repayment Capacity Interest Expense Ratio = Total farm interest expense Gross farm revenues Low Stress High Stress
Measuring Efficiency Asset Turnover Ratio = Gross farm revenues Average total farm assets Low Stress High Stress