Basics of Financial Forms & Enterprise Returns Peyton Fair – Farm Credit Mid-America Les Humpal – UT Extension Danny Morris – UT Extension Topics to be covered • Basics of a Business Plan • Basics of a Balance Sheet • Basics of Income Statement • Highlights of Tax Returns and Business Organization • Examples of each topic • Discuss how all are interrelated Basics of the Balance Sheet • What is a balance sheet? “A statement of financial position [that] provides information about an entity’s assets, liabilities, and equity, and their relationships to each other at a moment in time.” - Financial Accounting Standards Board, 1984 Basics of the Balance Sheet • Why prepare a balance sheet? – They can be used to: • Measure the business’s ability to meet its financial obligations in a timely manner • Compare financial performance to other operations • Performance measures for tracking progress toward financial goals • Document the farm’s financial position to outside parties such as lenders and accountants • Measure financial progress of the farm over time Basics of the Balance Sheet • It provides a snapshot of a individual’s, or business’s, assets and liabilities at a moment in time along with their net worth. • Assets and Liabilities are broken up into three separate categories: – Current – Intermediate – Long Term • Net Worth is defined as the difference between assets and liabilities. – Assets – Liabilities = Net Worth Basics of the Balance Sheet: Assets • Current Assets – defined as assets that can be easily converted into cash within one year. – Liquid assets – those that are easily converted to cash such as accounts receivable, crops, marketable livestock. – Assets are that are continually used up and replenished during the normal operations of the business Example of Current Assets: Cow-Calf Operation Basics of the Balance Sheet: Intermediate Assets • Intermediate Assets – assets that have a useful live of more than 12 months. These assets are used over time in the day to day operations of the business. – Includes items such as: • Equipment and Machinery • Breeding livestock • Titled Vehicles Examples of Intermediate Assets: Small Row Crop Farmer Basics of the Balance Sheet: Long Term Assets • Long Term assets are comprised of fixed assets with a useful life that often exceeds 10 years. – Examples of Long Term Assets: • Land • Buildings/facilities such as barns, grain bins, etc. – Types of facilities will vary from operation to operation » Some agriculture ventures require more facilities • Homes Examples of Long Term Assets: Niche Market Producer Market Long Term Assets Value Land Acres 91 235,000 55 217,500 Bldgs and Improvements 163,000 Retirement Accts 34,500 Other long term assets - Total Long Term Assets 650,000 Basics of the Balance Sheet: Liabilities • Liabilities – claims against assets; a sum of money that is owed by one party to another payable either at a set time or on demand. • Current Liabilities – debts that must be satisfied within one year Basics of the Balance Sheet: Liabilities • Examples of Current Liabilities: – Accounts Payable: Expenses that are sometimes charged include feed, fertilizer, fuel, etc. – Short Term Debt – operating lines of credit – Current Maturity of Long Term Debt – the portion of long term debt obligations that are due over the course of the next 12 months • Example: Principal and interest payments on equipment or land. Examples of Current Liabilities: Cow-Calf Producer Basics of the Balance Sheet: Intermediate Liabilities • Intermediate Liabilities tend to consist of debts that have a maturity greater than a year, but less than five to seven years. – Examples: • Machinery and equipment debt • Titled vehicles loans • Lease agreements • Cattle (or other livestock) notes Examples of Intermediate Debt: Small Row Crop Producer Basics of the Balance Sheet: Long Term Liabilities • Long Term Liabilities consist of debts that have a maturity greater than five to seven years. – Examples of Long Term Liabilities • Land notes • Loans for facilities such as barns, grain bins, etc. • Home Mortgages Examples of Long Term Liabilities: Niche Market Producer Long Term Loans Loan Int. Rate CP Principal NC Principal Balance FC - Land Note 4.20 4,680 165,455 170,135 FC - Land Note 4.80 2,040 124,186 126,226 FC - Berry Farm 3.40 3,444 112,856 116,300 Total Long Term Loans 412,661 Balance Sheet: Net Worth • Net Worth – total assets minus total liabilities; sometimes called “equity” – Denotes the amount of the owner’s investment in the business – Net worth improves as retained net income is invested back into the business and reduced by net losses of the business. – Net Worth can also be increased by how much the owner contributes to the business or decreased by how much the owner takes out of the business. Balance Sheet: Things to Consider • A balance sheet is only as accurate as the information that is put into it. • Make sure that all values are as of the date of the balance sheet. – For debts, know the interest rate, payment amount, date of payment, and frequency of payments for a detailed balance sheet. • Determine if you are going to value assets as market value versus cost of the asset. – Most balance sheets use market value. Balance Sheets: Market Value vs. Cost Value • Cost Value – the initial cost of the asset, plus improvements, minus accumulated depreciation. • Market Value – the estimate of what the asset would sell for. – Used by most producers – Can cause net worth to fluctuate greatly as market values change The Income Statement • What it accounts for: – The financial statement that measures the results of operations by matching revenues and expenses of a business during a specified time frame. • Lists all revenues of the business • Deducts all operating expenses of the business • Details if the business generated a net income or net loss – Measures the profitability of the farm The Income Statement • What it does not account for: – Loan payments for debts related to the business – Income taxes that is owed on the earnings of the business. • Taxes are only owed if there is a profit generated. – Owner withdrawals unless they are paid in the form of wages/salaries. – Family living expenses • Unless, living expenses are comingled with the expenses of the business. The Income Statement • What information do I need to complete one? – All income/revenue items – All expenses – Depreciation – Changes in inventory items The Income Statement • Net Farm Income – likely the most critical information from the income statement; determines profit or loss – However, farm operations are unique in that operators tend to not take a wage or claim a labor expense as they provide most of the labor. – The Farm Financial Standards Council defines Net Farm Income as the return to operator and unpaid family labor, management, and equity capital. – Why mention this? • You will have both an income and expense item in your operation that may not have an assigned value. Your time! Examples of Cow-calf Producer Income Statement Examples of Small Row Crop Producer Income Statement Examples of Niche Market Producer Income Statement Income Statement Farm Plan Blackberry sales 71,141 Poultry sales 1,500 Custom hire income 755 Gross Farm Income 73,396 Car and truck - Chemical - Conservation 400 Custom Hire - Employee Benefits - Feed 300 Fertilizer 800 Freight 500 Fuel 9,500 Insurance 2,000 Interest 25,528 Labor - Rent - Repairs 10,384 Nonfarm Income Seed 700 Wages 139,396 Storage - Retirement - Supplies - Other Nonfarm Income - Taxes 5,570 Utilities - Nonfarm Expense - Veterinary 1,500 Other Farm Expenses 4,387 Net Nonfarm Income 139,396 Total cash farm expense 61,569 Net Income Before Living & Income Tax 133,863 Net farm cash income 11,827 Depreciation 17,360 Net farm income (5,533) Income Statement: Things to Consider • Revenues – Do not overstate income items – Be realistic with sales expectations and prices – If you have not had this level of income in the past, why do you think that you will going forward? • Expenses – Be realistic with expenses and gather actual costs from suppliers – Account for every expense imaginable • Better to overstate expenses rather than have surprises • Along with variable expenses account for fixed expenses The Income Statement • Earlier, we stated that the income statement does not account for everything. • It does detail if you made a net farm income/loss, but it does not tell you exactly how much cash you made. • Why? – It misses: • Taxes • Debt Payments • Family Living Expenses • Non-farm Income • How do we account for these and figure cash earned? – Cash Flow Analysis Cash Flow Analysis • Cash Flow Statement – provides information about the cash inflows and outflows from operations of the business along with financing and investing activities. • Cash flow from operations – amount of cash generated from/used by a business enterprise’s normal, ongoing operations – This is what we are interested in. Cash Flow Analysis • Cash flow analysis tells you how much cash is left after: – Operating expenses – Taxes – Debt payments (P&I payments) – Non-farm income and expense items Cash Flow Analysis • Common method to evaluate a business’s cash flow is capital debt repayment capacity. – Measures the ability of the operation to generate enough funds to cover debt repayment and replace assets. • A common ratio that takes this a step further is term debt coverage. – This measures the ability to cover all loan payments; the greater the ratio over 1:1, the greater margin to cover payments Example of Cash Flow Analysis Why is this information important? • These forms can assist you in being a better manager. • These financial forms will be crucial in understanding the financial position of your operation. • An understanding of these forms and what day-to-day operation decisions impact the overall bottom line can help in securing a loan. • A complete cash flow statement will: – Help you understand where income was generated and where it was spent (i.e.