Agricultural Balance Sheet Secrets

Newsletter #10 - a first milestone!

Before we continue our 3-part mini-series on financial statements, I want to share this thought here as well:

I know many of us, especially since Covid, have resorted to doing almost everything online. And our days have become monotonous routines.

This is a reminder to break that cycle! It’s worth it 🌷

Last week, I wrote about the importance of the income statement and how it helps you see if you are making an economic profit.

Today, we’ll go over the statement where this profit ends up: the Balance Sheet. Banks love this one.

Note: if you already know all of this, scroll down to the “How you can use your balance sheet” section, which might still be useful for you.

Quickly covering the basics

The Balance Sheet is a snapshot of your business at a specific point in time. It shows you what you own, and how you paid for all of that (what you owe).

And as you know, it’s called the “Balance” Sheet as your Assets must always equal your Liabilities + Equity (how you paid for the Assets). So what you Own and Owe is in balance.

But did you already spot the reason why balance sheets aren’t thaaaattt usefull?

Did you see it? “snapshot… at a specific point in time”?

The balance sheet, especially when it’s a couple of months old, can be deceiving!

Why is that?

Let’s say you grow tulips and prepare your Balance Sheet in December every year.

You do have a lot of assets that have pretty stable values, think of your machines and buildings. But, you also have assets that change very quickly in value: all your tulips that are ready to be sold!

You can value all your tulips based on your production cost or the market value and conclude that they are worth £500,000. This number ends up on your balance sheet as Inventory. But now March rolls around and all of your tulips are sold again.

So while in March the balance sheet is only 3 months old, the dynamics have changed completely. This can be dangerous when you simply use your balance sheet to calculate all sorts of ratios that rely on specific numbers.

Other examples are acquisitions, new machines, land values and you name it. Things always change, and a balance sheet is outdated VERY quickly.

But, just like the income statement, there is a time and place for it. Especially when you compare it year over year, or when you want high-level information: like how much debt does the business have?

Quick introduction of the important elements

The Balance Sheet includes the following categories, each representing a different aspect of your financial position:

• Cash: Represents the amount of money you have on hand or in your bank accounts.

• Accounts Receivable: Reflects the money owed by customers or clients for goods or services provided.

• Inventory: Accounts for the value of crops, livestock, and other products held for sale or production.

• Land and Buildings: Represents the value of your real estate holdings, including farmland, buildings, and infrastructure.

• Equipment and Machinery: Accounts for the value of your machinery, vehicles, and other equipment used in operations.

• Accounts Payable: Represents the amount your farm owes to suppliers, vendors, or creditors for goods or services received.

• Long-Term Debt: Reflects the portion of your farm's loans or financial obligations that extend beyond one year.

• Equity: Represents the ownership interest or residual value of your farm after deducting liabilities from assets.

How you can use your balance sheet

One thing I like to use the Balance Sheet for is to help set a Capital Structure.

This is just a fancy finance word for how much Debt you are comfortable with. How much this is should depend on your personal risk tolerance and your specific business (how many assets you own, your cash flow patterns etc.).

But let’s say you feel comfortable with 50% debt financing (knowing that you own your land and have stable cash flows).

Then one year you make a lot of profit, and your equity increases, and now your capital structure changed to 40% debt and 60% equity. This could give you the confidence to take on more debt for a new expansion to get back to your target of 50%.

You will never keep it stable at 50%. But this can just be another useful guidepost to help you improve your decision-making and feel good about your business.

The Agricultural Twist

To end the balance sheet section, here are some things to watch out for specifically in Ag:

1. Valuation of Inventory: Unlike many other industries, agriculture grows or raises its own inventory. You have to take this valuation with a grain of salt and realise how volatile it can be.

2. Neglecting to update asset values: most assets on a balance sheet are depreciated over their useful life. But in Agriculture we have many assets (land, even equipment in the last years) that increase in value. Keeping these values up to date is important to calculate your capital structure and loan-to-value numbers.

3. Depreciation Considerations: still, most assets decrease in value. And in agriculture, these assets are worth a lot of money. That’s why the depreciation expense is often much higher than in other industries.
   Side note: depreciation does lower taxes. If you have equipment sitting in your barn that is not recorded in your books, you might be missing out!

4. Seasonality: seasonality can mean your balance sheet items (like cash, receivables and payables) can fluctuate a lot throughout the year. That’s why it often pays to at least keep management figures weekly or monthly for yourself. Most accounting packages can do this for you.

I hope that was useful. If you have any doubts about your balance sheet I’ll be happy to review it for free. Just let me know 🌷

Till next week,

Joey