A Balance Sheet for Better Farm Management
It’s the time of year for reviewing year-end financials, completing required reports and establishing a tax plan. With all the hours to be logged in the office, be sure you dedicate some attention to updating your balance sheet before the ground thaws and planting season begins.
A balance sheet provides a full financial picture of your farm. An annual update is important because it:
- Provides insight into where your business stands at a point in time
- Serves as a communication tool with others in the business
- Allows your lender to understand your current situation
Most importantly, an updated balance sheet can help you become a better financial manager.
What goes into a balance sheet?
In short, a balance sheet is a snapshot in time of all assets and liabilities, categorized as being:
- Current – Items that will be sold or turned into cash in the next 12 months (asset) or a bill that will require payment within 12 months (liability).
- Intermediate – Items that aren’t normally sold during the year including, breeding livestock, machinery, vehicles, retirement accounts and cash value of life insurance (asset) or a loan with a maturity date between one and 10 years (liability).
- Long-term – Real estate and improvements, including land, buildings, and grain systems, for assets and loans with maturity dates greater than 10 years for liability.
The information available in your balance sheet can be plugged into the following equations to gain valuable insight relating to your business. When consistently updated, your balance sheet will be a trusty tool for understanding how your business changed from year to year. You can also see how it is performing in relationship to similar farms by matching your numbers against industry benchmarks available through your lender, accountant or state university.
These comparisons will guide you in creating a strong and complete balance sheet that can help uncover opportunities for improvement and increase understanding of how future purchases will affect your financial position.
Equations you can use with your balance sheet include the following:
- Total Assets - Total Liabilities = Net Worth
- Net Worth/Total Assets = Ownership Equity
- Current Assets - Current Liabilities = Working Capital
- Working Capital/Acres Farmed = Working Capital per Crop Acre
- Long Term Liabilities/Acres Farmed = Land Debt per Owned Crop Acre
- Value of Machinery and Farm Vehicles/Acres Farmed = Total Machinery and Vehicle Investment per Crop Acre
Here’s a quick primer on the ratios that can be learned through the above equations, as well as a couple of targets:
- Net Worth – The dollar amount (less possible income taxes) that would result from the sale of all crops, machinery, land and any other asset.
- Ownership Equity – The percentage of the assets on your balance sheet that you own, versus borrowed funds. Ownership equity tends to start out low for a beginning farmer and grows over time as the operation becomes more established. The percentage will fluctuate over time and with additional purchases. Large decreases in ownership equity are typically related to land purchases. Ownership Equity should stay above 50%, even when large purchases are involved.
- Working Capital – The liquidity in your business to pay short-term obligations. Working capital is likely to change each year, depending on earnings and if purchases are made outright or through down payments. Your farm’s working capital should be at 33% of gross revenue for the whole operation as well as on a per acre basis. For example, if you grow all corn with an average of 200 bushels at price of $3.50 or $700 gross per acre, the working capital goal would be $231 per acre.
- Land Debt per Acre – The amount of debt when compared to land owned, which affect your ability to stay in business during a cyclical downturn. Each farm is different based on real estate tax, paid interest and crop yield. This number can be used to calculate a payment per tillable acre, with a cash rent equivalent determined once real estate tax per acre is added in. It’s important to think about this number when the purchase of another farm is being considered.
- Total Machinery and Vehicle Investment per Acre – Relays how much you have invested in your machinery for every acre you farm. For grain operations, a goal to strive for is $575 per crop acre or lower. This number could vary for farms that have livestock or do a significant amount of custom work.
If your numbers aren’t as good as you’d like them to be after taking a closer look at these ratios, there are options to consider:
- Net Worth is changed by after tax earnings, gifts, asset appreciation and inheritance. Focus on earnings to increase net worth.
- Since Ownership Equity is a ratio, you can control it by the same items as Net Worth but it can be affected by selling an asset to reduce debt. Typically, selling a non-income producing asset will help your overall financial position.
- If earnings from the farm are not sufficient to make all payments and cover living expenses, your working capital will decrease as you borrow funds to make the payments. Consider building working capital by selling capital items, like unused machinery, to generate cash.
As with any financial document, it’s important to review your balance sheet for accuracy. It’s also important to put your balance sheet to work once you’ve updated it. Still need to complete your balance sheet? Visit Compeer.com for a free template under tools and resources.