Quick Notes...

All businesses (including agriculture) shouldprepare a balance sheet each year based on arecommended set of guidelines to insureuniformity of reporting.

A balance sheet or net worth statement is asummary of the assets and liabilities, andowners equity (net worth) as of a specifictime.

Agriculture & Business

Management Notes ...

Preparing a Balance Sheet

The critical need for enhanced financialmanagement skills and techniques inproduction agriculture became apparent in the1980s. The decade of the 1980s, particularlythe period 1981 through 1987, saw thefinancial position and conditions of manyoperations deteriorate. Many producers werefaced with insufficient cash flow, decliningasset values, rationing of capital byagricultural lenders, voluntary or forcedliquidation, foreclosure (total or partial), andbankruptcy. The stress of the financialsituation was felt throughout theagricultural sector - including lenders, retailtrade and the service sector. The financial stress was documented by loandelinquencies and losses, inadequate securitiesfor loans, reduced business volume, and otherincome flows within the rural/regionaleconomies.

The financial distress was a consequence of anumber of factors which were in place duringthe 1970s, but reversed direction in the early1980s. These factors include but are notlimited to:

1. Inflation (increasing land values primarily). 2. Favorable foreign exchange rates. 3. Strong export market (strong international market). 4. Low "real" interest rates (negative real rate in 1974 and 1975). 5. Increased commodity supplies (capacity was expanded by 20 percent in the 1970s).

The financial distress among farmers/ranchersand agricultural lenders was rooted in theinflationary decade of the 1970s, andsubsequent adjustments from that period tosharply different economic conditions in the1980s. Throughout the 1970s, farmers andranchers faced rapidly expanding exports,accelerating inflation, and low to negative realinterest rates (the nominal interest rate minusthe inflation rate). Farmers and ranchersresponded by borrowing heavily to invest innew equipment, adopt new productiontechnologies, and purchase increasinglyexpensive land. Farm debt rose an average ofmore than 10 percent a year. Yet land valuesrose even faster, providing the economicincentive for producers and lenders to expand

Colorado State University, U.S. Department of Agriculture and Colorado counties cooperating. Extension programs are available to all without discrimination.

No endorsement of products is intended nor is criticism of products mentioned.

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and roll over debt. Debt/asset ratios of farmsdeclined over the 1970s.

By the early 1980s, the factors that had givenrise to the expansion had reversed direction. Worldwide recession weakened internationalmarkets; the value of the dollar rose rapidlyagainst major foreign currencies, furtherdampening export demand; and inflation wasslowed by stringent control of monetarygrowth. Real interest rates, which had beenlow or negative throughout the 1970s, jumpedto unprecedented levels of 8 to 10 percent. Agricultural commodities in foreign anddomestic markets were too plentiful to sustainthe prices that had prevailed during the 1970s,causing commodity prices and producerincomes to drop significantly. Land values,which depend on both current farm incomeand prospects for future income growth, alsobegin to decline. The debt levels that someproducers had assumed over the 1970s wereno longer sustainable. Agricultural operationswhose solvency depended on continuouslyrising land values or who pursued anaggressive expansion strategy were pushedtoward insolvency. Moreover, even thoseproducers who pursued more cautiousfinancial strategies in the 1970s, but sufferedfrom the 1980 or 1983 droughts or othernatural disasters, faced financial stress for adifferent reason.

The need for enhanced financial managementskills and techniques became critical to manyagricultural producers. Many efforts wereundertaken in the public and private sector inan attempt to fulfill this need. This need,coupled with the growth and development ofthe micro computer, resulted in many productsthat were helpful but often incompatible. Inthe following section, discussion related to thestandardization of financial reporting andanalysis and its evolvement through efforts ofthe Farm Financial Standards Task Force(FFSTF) is presented.

History of The Farm Financial Standards

Task ForceThe following paragraphs, selected from thepublication Recommendations of the FarmFinancial Standards Task Force, clearlyoutline the need for standardization offinancial reporting in agriculture (2). Sincethis chapter adheres to the recommendationsof this document, it is important that thebackground be established.

"During the decade of the 1980s, forces wereset in motion that substantially changed themethods of analyzing financial strengths andproviding credit to production agriculture. Through most of that decade the farmfinancial industry was in turmoil caused by anunforeseen run-up in interest rates, recordlevels of farm debt, large fluctuations in farmincome, a rapid decline in the value of farmassets, and insufficient or under-utilizedmethods for analyzing the true profitability ofvarious farm enterprises.

This environment created an increased interestin farm financial education and sophisticatedfinancial analysis techniques. The demandbrought about a rapid expansion in the numberof products and services available for thisanalysis. Because each new system utilizedits own specific method for analyzing farmoperations, it was often difficult foragricultural producers, lenders, or farmfinancial experts to conduct comparativeanalysis between farming operations.

The lack of standardization in farm financialanalysis caused problems in understandingand using data for decisions, and was oftencited as a substantial barrier to theaccessibility of funds from capital markets. The magnitude of the problem wasunderscored when Congress passed the 1987Agricultural Credit Act. During the debate onthis legislation, experts testified that the lackof uniformity in analyzing farm operationswould prohibit the establishment of privatizedsecondary markets for agriculture. Thus,when the legislation was enacted, it contained

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provisions for the government to sponsor asecondary market for agricultural real estateloans.

At the same time that Congress was workingon the 1987 Agricultural Credit Act, theNational Commission on AgriculturalFinance, appointed by President Reagan, wasexamining the farm financial industry. ThisCommission cited a need for standardizationof agricultural credit analysis and farmfinancial statements. Their report claimedthat, without standardization nationwide, theagricultural industry would have difficultylearning how to analyze the financial strengthof their operations, and agricultural producerswould probably pay a premium for borrowedfunds as a result.

Thus, the overwhelming evidence from allsectors seemed to indicate that agriculturalproducers, lenders, financial analysts, andagricultural economists could make betterfinancial management decisions by uniformlydefining the data, criteria, and measures thatare most useful in addressing specific farmfinancial questions. In response to this issue,the Executive Committee of the AgriculturalBankers Division of the American BankersAssociation (ABA) formed the Farm FinancialStandards Task Force (FFSTF)."

The following discussion provides anoverview of the recommendations of theFFSTF. The minimum set of financialstatements are discussed as well as therecommended financial measures ofperformance analysis. Each financialstatement is presented and discussed briefly. It is recommended that the reader acquire acopy of the FFSTF recommendations to gainfurther detail.

The minimum set of financial statementsrecommended by the FFSTF include:

Balance Sheet Income Statement

Statement of Cash Flows Statement of Owner Equity

Further, it is extremely important that thestatements be prepared on a consistent basis,i.e. cover identical time periods. The taskforce did not develop specific formats forthese financial statements; only recommendedgeneral guidelines to ensure uniformity ofreporting. As such, financial analyses (ratioand comparative analyses) is more uniform. The following is a brief description of each ofthe financial statements and the type ofmanagement decisions for which each of thestatements can be used.

Balance SheetIn this section, the foundation of the balancesheet will be laid. The balance sheet can bederived from the fundamentalaccounting equation:

Assets = Owner's Liabilities + Owner Equity OROwner Equity = Assets - Liabilities

Traditionally, the balance sheet is arrangedsuch that assets are listed on the left side andliabilities and owner's equity on the right side.The balance sheet has historically been theprimary (and often only) financial statementused for agricultural lending. Until the eventsof 1980s demonstrated the necessity of morefinancial information for proper financialmanagement, the balance sheet was reliedupon as the means to evaluate potentialborrowers.

The balance sheet must balance, hence thename balance sheet--total assets equal to totalliabilities and net worth (owner equity).

What items fall under each of thesecategories? The following definitions aid inclassifying both assets and liabilities.

Current assets: Items that are held for sale,cash on hand, savings, inventory of products

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that could be sold, and financial instrumentsthat are readily convertible to cash (e.g.,shares in IBM).

Current liabilities: Items that are due andmust be paid within the next year. This wouldinclude outstanding feed, fertilizer, wages,fuel bills, etc. Also included are accruedinterest and principal payments on operatingnotes, machinery, livestock loans, real estatemortgage payments and lease payments dueduring the next year.

Non-current assets: Tend to be the workingassets and real estate (including buildings and

improvements). Working assets includemachinery, equipment and breeding stock. Others include stock in Farm Credit Servicesor other similar entities that have value but arenot readily marketable. Often life insurancepolicies with cash value are placed in thiscategory. Recreational and personal assetsmay or may not be listed.

Non-current liabilities: Account for theloans for machinery, equipment, livestock orreal estate and other financial obligations thathave a term greater, than one year. Thus, anyliabilities that have been amortized for morethan one year would be listed in this section.

The balance sheet is structured as follows:

Assets Liabilities

Current: ________ Current: ________

Non-Current: ________ Intermediate: ________

Net Worth: ________

Total Assets: ________Total Liabilitiesand Net Worth:

Balance sheets are normally prepared forseparate entities even in a sole proprietorship. GAAP guidelines in traditional accountingsupport that the business be reportedseparately from its owner. The exception isagriculture where producers and lenders prefera consolidated or combined statement. Acombined statement includes both personaland business assets and liabilities.

Notes... (For More Information) Contact: Norm Dalsted, Dept. of Ag. & Resource Economics, Network CSU, (970) 491-5627 Norman.Dalsted@colostate.edu

(Updated August 2008)