Activity 2.2.1 a Balancing Act

Name______

Activity 2.2.1 A Balancing Act

Purpose Balance sheets measure how assets and liabilities offset each other. Assets are owned items or cash in hand. Liabilities represent money owed to someone else. Assets and liabilities are listed on a balance sheet to compare their values.

Assets and liabilities are divided into current and noncurrent categories, according to the one-year rule. Current occurs within one year, and noncurrent lasts longer than one year.

Current assets are used up or sold within one year, such as feed, seed, fertilizer, ingredients, market animals, and fuel. Cash on hand and in bank accounts, are current assets. Accounts receivable, or money owed to the business within the year, are also listed under current assets. Noncurrent assets have useful lives longer than one year, such as buildings, machinery, computers, land, and breeding livestock.

Current liabilities must be paid within one year of the date of the balance sheet. Bills, such as credit card statements and utilities, are often due every month. Short-term loans include those due in six months or one year, also qualify as current liabilities. Accounts payable, or money owed to another business within the year, are current liabilities. Mortgages and equipment loans are longer-term and are classified as noncurrent liabilities.

Total assets add value to the business and total liabilities detract from the value of the business. Calculate net worth by subtracting total liabilities from total assets. Net worth is also called owner’s equity. Business owners judge the health of a business by comparing assets to liabilities. Managers analyze balance sheets for planning purposes.

How are assets and liabilities organized on a balance sheet? How do you complete a balance sheet for business analysis? Figure 1. Comparing Assets and Liabilities

Materials

Per student: • Pencil • ABF Notebook • Calculator

Procedure Arrange assets and liabilities according to the categories in a balance sheet, then compare businesses.

Part One – Classifying Assets and Liabilities 1. In the space provided on the student worksheet, write what you know about the terms current, noncurrent, asset, and liability. Refer to your notes and research as needed. Record all questions you have about each term.

2. Review the list of assets and liabilities in Table 3 on the student worksheet. In the classification column, identify the most appropriate classification for each item each using the following designations. • CA = current asset • CL = current liability • NCA = noncurrent asset • NCL = noncurrent liability 3. Your teacher will review the designations with your class before you move on to Step 4. 4. Write each item in the proper category for the balance sheet in Table 4 on the student worksheet. For every item, enter one dollar in the value column of the balance sheet.

Part Two – Calculations Now that you have filled in the top portion of a balance sheet by identifying the assets and liabilities, the next step is to calculate the totals. Total each category in the lines provided in Table 4, then calculate the four equations, shown below, at the bottom of the same table.

Total Assets TA = CA + NCA A + B = C

Total Liabilities TL = CL + NCL D + E = F

Owner’s Equity (Net Worth) NW = TA - TL C – F = G

Total Liabilities + Owner’s Equity TL + NW F + G = H

Figure 2. Balance Sheet Equations

Part Three – Comparing Balance Sheets 1. Review the balance sheet entries for Mario’s Nursery listed in Table 1. Place each entry into the correct category within the balance sheet for Mario’s Nursery in Table 5 on the student worksheet. Table 1. Balance Sheet Entries for Mario’s Nursery Entry Amount Entry Amount Account payable to Elmwood Wholesalers $2,500 Loan principal for utility tractor, due this year $1,500 for seedlings, due in two months Account receivable from John Smith for 2,500 Nursery building and lot 125,000 landscaping services performed last month

Cash on hand 10,500 Operating loan payment, due in six months 10,000

Credit card bill, due next month 2,000 Potted trees for resale 10,000

Principal remaining for nursery mortgage, Employee wages, due this month 1,500 25,000 due after this year

Inventory for resale 5,000 Seedlings for resale 10,000

Loan principal for truck and trailer, due after 10,000 Truck and trailer 25,000 this year Loan principal for utility tractor, due after 15,000 Utility bills, due this month 500 this year Loan principal for truck and trailer, due this 1,000 Utility tractor 25,000 year

2. Calculate the totals for each category, then compute the total assets, total liabilities, owner’s equity, and total liabilities + owner’s equity, as shown in Part Two.

3. Repeat Steps 1 – 2 using the information for Zelda’s Dairy in Table 2, and the balance sheet in Table 6 on the student worksheet. Table 2. Balance Sheet Entries for Zelda’s Dairy Entry Amount Entry Amount Bottle calves for sale $5,000 Machinery and equipment $250,000

Checking and savings accounts 25,000 Milk check, account receivable 15,000

Dairy barns 500,000 Operating loan payment, due this year 75,000

Dairy cows 200,000 Pasture and farmland 500,000

Principal remaining for dairy barn mortgage, Feed bill, due in two months 15,000 475,000 due after this year Principal remaining for land mortgage, due Feed on hand 30,000 475,000 after this year

Loan principal for cows, due after this year 175,000 Replacement heifers 50,000

Loan principal for machinery, due after this 200,000 Utility bill due this month 2,500 year

Loan principal for machinery, due this year 50,000 Veterinary bill, due this month 2,500

4. Refer to the two completed sample balance sheets to answer the analysis questions on the student worksheet.

Conclusion 1. What are two examples of assets that you might need for a business? What are two examples of liabilities you might encounter as a business owner?

2. How are current assets and noncurrent assets different?

3. What is owner’s equity, or net worth, and why is this calculation important?

4. What is the financial situation of a business that has more total liabilities than total assets?

Name______Activity 2.2.1 Student Worksheet

Current Noncurrent What you know: What you know:

Questions you have: Questions you have:

Asset Liability What you know: What you know:

Questions you have: Questions you have:

Table 3. Sample Balance Sheet Entries Entry Classification Amount Entry Classification Amount Fertilizer $1.00 Bill for lumber due $1.00

Neighbor owes money 1.00 Breeding mare 1.00 Credit card bill due this Equipment loan balance, 1.00 1.00 month due after this year Interest payment due this Property mortgage due 1.00 1.00 year after this year Land 1.00 Fences 1.00

Pickup 1.00 Hay for sale 1.00

Plow 1.00 Property taxes due 1.00

Market steer 1.00 Tractor 1.00

Cash in bank account 1.00 Trailer 1.00

Table 4. Balance Sheet Balance Sheet Current Assets (CA) Current Liabilities (CL) $ $

Total Current Assets (A) $ Total Current Liabilities (D) $ Noncurrent Assets (NCA) Noncurrent Liabilities (NCL) $ $

Total Noncurrent Assets (B) $ Total Noncurrent Liabilities (E) $ Total Assets (C) $ Total Liabilities (F) $ Owner’s Equity (Net Worth) (G) $ Total Liabilities + Owner’s Equity (H) $

Table 5. Mario’s Nursery Balance Sheet Table 6. Zelda’s Dairy Balance Sheet Balance Sheet Balance Sheet Current Assets (CA) Current Liabilities (CL) Current Assets (CA) Current Liabilities (CL) $ $ $ $

Total Current Total Current Liabilities Total Current Assets (A) $ $ Total Current Assets (A) $ $ Liabilities (D) (D) Noncurrent Assets (NCA) Noncurrent Liabilities (NCL) Noncurrent Assets (NCA) Noncurrent Liabilities (NCL) $ $ $ $

Total Noncurrent Assets Total Noncurrent Total Noncurrent Assets Total Noncurrent $ $ $ $ (B) Liabilities (E) (B) Liabilities (E) Total Assets (C) $ Total Liabilities (F) $ Total Assets (C) $ Total Liabilities (F) $

Owner’s Equity (Net Worth) (G) $ Owner’s Equity (Net Worth) (G) Total Liabilities Total Liabilities $ $ + Owner’s Equity (H) + Owner’s Equity (H)

Analysis Questions • Is the value of the owner’s equity, or net worth, positive or negative for Mario’s Nursery?

• Is the value of the owner’s equity, or net worth, positive or negative for Zelda’s Dairy?

• Which of the two businesses is healthier, in your opinion? Why?

• What is the relationship between total assets (C) and the sum of total liabilities and owner’s equity (H)?