Knowing and analyzing how your farm is performing is one of the most important jobs you, as a farm business owner, should be doing on a regular basis. Most farmers will analyze how well their products have grown/performed on a regular basis, which is a great thing to do. However, how often do you look at your financial performance or year-end financial statements? There is important information contained in your financial statements that is used by your lender, your advisor, and by you, as the owner. In this article, we will look at the balance sheet.
The Purpose of the Balance Sheet
A balance sheet is a list all the farm business’ assets, liabilities and owner’s equity/net worth at a certain point in time (i.e., as of December XX, 202X). The statement must “balance” (thus the name) because it tells the story of what is owned (assets) and how they were purchased (liabilities— debts; and owner’s equity— what the owner contributed). The formula for a balance sheet is Assets = Liabilities + Net Worth.
Some of the questions that your balance sheet should answer include:
- Does the business have the assets to generate income?
- Can the farm have enough cash or similar assets to pay off debt that is due within the next 12 months?
- How much of the business is financed through debt?
- If I sell the farm business, how much money would be left over, after all of the assets are sold, and debts are paid?
Balance sheets that are prepared for a year end will outline all the assets and liabilities as of the end of the year. The balance sheet can be summarized or detailed. A summarized balance sheet (Figure 1) provides a good overview of your farm business’ financial position. A detailed balance sheet would be better used for more detailed analysis and answering other specific questions (i.e., how much of the veal inventory are for veal calves that are close to market weight, compared to just purchased?).
How to Prepare a Balance Sheet
If your accountant/bookkeeper does not prepare a balance sheet, that is not a problem. If you use a software accounting program to do your bookkeeping, there is usually an option to run a balance sheet report. If you are unsure how to do this, you can consult your software manual, or talk with your accountant or income tax preparer and they can assist.
If you use a spreadsheet to track your bookkeeping entries, you can use Ontario Farm Accounting Workbook, which can take you through the process of recording all of your assets and liabilities. If you work with a lender, you have most likely provided them with a listing of your assets and liabilities. This is a good place to start preparing/updating your balance sheet.
How to Analyze Your Business Using the Balance Sheet
Once you have prepared your balance sheet, it is time to start analyzing your business. The Quick Ratio or Acid Test is an important financial ratio for you to understand and review on a regular basis. This ratio shows how well a business can pay off its current liabilities (debt due within 12 months), using cash or cash-like assets (e.g. cashable GICs). A Quick Ratio or Acid Test less than 1 means that your business does not have enough cash or cash like assets to pay off your current liabilities. This is a financially challenging position. A Quick Ratio or Acid Test greater than 1 is much more ideal.
This ratio is important, but a word of caution, balance sheet ratios are for a specific point in time, so they are just one aspect of a financial ratio analysis to look at. There are other ratios that can also help further analyze your farm business financial situation. We will be discussing these in future articles, so stay tuned. Preparing and analyzing your balance sheet is a great way for you to examine how your farm business is doing. This information can be used to forewarn you of possible issues that may negatively affect your farm’s financial position, so that you can make changes to prevent the situation.
This was originally published in “The Connection” for Veal Farmers Ontario by Erich Weber, Business Finance Specialist.