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Financial Documentation Basics: How Do I get Started?. Objectives. Understand the basics of accurately measuring financial performance (profitability) Explore issues that affect the completeness and accuracy of financial statement information

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objectives
Objectives
  • Understand the basics of accurately measuring financial performance (profitability)
  • Explore issues that affect the completeness and accuracy of financial statement information
  • Examine the impact of these issues on financial performance measures
basic financial statements
Basic Financial Statements
  • Balance Sheet (beginning and ending)

Assets, liabilities & equity

  • Income Statement

Revenue, expenses and profit

  • Statement of Owner Equity

Sources of change in equity

  • Statement of Cash Flows

Sources of change in cash

slide5

End of Year

BALANCE SHEET

Assets

Liabilities

Equity

Beginning of Year

BALANCE SHEET

Assets

Liabilities

Equity

STATEMENT OF OWNER EQUITY

Change in equityOwner contributions, retained earnings, & valuation

INCOME STATEMENT

Revenues and gains minus expenses and losses

PLUS

EQUALS

STATEMENT OF CASH FLOWS

Inflows of cash minus outflows of cash (change in each balance sheet account from the beginning to the end of the accounting period to determine how those changes affected the cash account)

EQUALS

PLUS

what entity
What Entity?
  • Entity Concept: business accounts are kept for business entities rather than the persons who own and operate them.
  • Personal financial information can be reported in a personal financial statement called a Statement of Financial Condition.
  • Personal financial information

must be separated from

business information.

entities
Entities

Farm Business

Contributions

Owners

Withdrawals

measuring net income accrual versus cash
Measuring Net Income - Accrual Versus Cash

Accrual financial reporting: recognizing income on the income statement in the period it is earned and expenses in the period in which they are incurred.

versus

Cash accounting: accounting for cash receipts when received and cash expenditures when paid.

slide9

Beginning of Year

BALANCE SHEET

Assets Current $337,747 Noncurrent $4,091,600

Liabilities Current $252,136 Term $891,220

Equity $3,285,991

End of Year

BALANCE SHEET

Assets Current $485,376 Noncurrent $4,170,100

Liabilities Current $321,867 Term $799,572

Equity $3,534,037

Precise classification of assets and liabilities is important!

types of accrual adjustments
Types of Accrual Adjustments
  • Current assets excluding cash

Examples: accounts receivable, grain/feed inventories, market livestock, supplies & prepaid expenses, investments in growing crops

  • Farm accounts payable
  • Accrued interest
  • Other accrued expenses
accrual adjustments noncurrent assets
Accrual Adjustments - Noncurrent Assets
  • Depreciation expense is an accrual adjustment typically associated with noncurrent section of the balance sheet.
  • Gains or losses on noncurrent assets that are an ordinary and necessary part of production activities (sales of cull cows/sows) are included in net income from operations.
  • Gains or losses on noncurrent assets that are nonrecurring are included in net income but not net income from operations.
slide12

End of Year

BALANCE SHEET

Assets

Liabilities

Equity

Beginning of Year

BALANCE SHEET

Assets

Liabilities

Equity

STATEMENT OF CASH FLOWS

BEGINNING CASH $157,689Operating activities Net cash income $52,421 - Cash withdrawals $150,000 -$97,579Investing activitiesCapital sales $63,800 - Capital purchases $97,895 -$34,095Financing activitiesNew borrowing $150,000 - Principal payments $170,999 -$20,999ENDING CASH $5,016

cost or market values

Cost or Market Values?

How should farm business assets be valued on the farm balance sheet?

A. Market

B. Cost

C. Both

general advantages
Market Values

Easy to derive

More comparable across farms

Benchmark data readily available

Better measure of opportunity cost

Required by lenders

Cost Values

More accurate measure of actual performance of invested capital

Better measure of financial progress over time

Critical for determining the sources of equity change in the business

General Advantages
what are the sources of equity
What are the sources of equity?
  • Paid-in capital/Contributed capital
    • Contributions of equity from owners
  • Retained earnings
    • Business generated net income less withdrawals from the business
  • Valuation equity
    • Excess of the market values of noncurrent assets over their cost values (investment less depreciation)
    • Valuation equity is unearned and may never be realized
slide18

Beginning of Year

BALANCE SHEET

Assets Current $337,747 Noncurrent $4,091,600

Liabilities Current $252,136 Term $891,220

Equity $3,285,991

End of Year

BALANCE SHEET

Assets Current $485,376 Noncurrent $4,170,100

Liabilities Current $321,867 Term $799,572

Equity $3,534,037

MBC Farms – Market Value Balance Sheets

Ending owner’s equity $3,534,037

Minus beginning owner’s equity $3,285,991

Equals increase in owner’s equity $ 248,046

The source may be as important as the amount!

valuation equity mbc farms
Valuation Equity: MBC Farms

Increase in valuation equity = (2,246,677– 2,129,151) = $117,526

slide20

Beginning of Year

BALANCE SHEET

Assets $4,429,347

Liabilities $1,143,356

Equity Contributed Cap $ 0 Retained Earnings $1,156,840 Valuation Equity $2,129,151Total Owner’s Equity $3,285,991

End of Year

BALANCE SHEET

Assets $ 4,655,476

Liabilities $ 1,121,439

Equity Contributed Cap $ 0 Retained Earnings $1,298,359 Valuation Equity $2,246,677Total Owner’s Equity $3,534,036

Statement of Changes in Owner’s Equity

Increase in contributed capital $ 0

Increase in retained earnings $ 130,519

Increase in valuation equity $ 117,526

Total change in equity $ 248,045

key points
Key Points?

1. Make accrual adjustments to accurately measure profitability and financial position

2. Cost and market value based measures are each useful in their own ways:

  • market for benchmarking, creditworthiness
  • cost for trend analysis, performance of invested capital, and evaluating leverage