February 11, 2021
Being well into the season of setting up operating loans and lines of credit, farmers should understand the documents required before they meet with lenders.
North Dakota Farm Management Edu-cation Program enrollees are working with their instructors to complete balance sheets, financial analyses and cash flow projections for 2021. At the same time, everyone has held numerous appointments with their income tax preparers.
How well do you understand the terminology used by your loan officer? Here’s a basic review of some common documents:
Balance sheet. A balance sheet is simply a list of all your assets and liabilities. From that, your net worth can be calculated — total assets minus total liabilities. A balance sheet may include just farm assets and liabilities, or also list personal items.
The term “balance” comes from the typical format used that has assets on the left side, with liabilities and net worth on the right side. Total assets will always equal total liabilities plus net worth. The important thing to remember about a balance sheet is that it is a snapshot of your assets and liabilities at the time it is put together. Your balance sheet may be obsolete and inaccurate tomorrow, so your lender will always need an updated balance sheet. Liquidity and solvency ratios are calculated from this statement.
Income statement. The balance sheet has nothing to do with income and expenses. Those are found on the income statement. It reveals if a farm or ranch was profitable.
An income statement might have three sections to it. First it lists all cash farm income and all cash farm expenses for the year. The difference is the net cash income. These are the numbers typically used on a Schedule F tax form.
To make an accrual-based income statement, the second section covers changes in inventory. Here is that concept using grain inventories as an example.
Grain on hand at the beginning of the year is not really this year’s income even if it was sold this year (that was last year’s business), so exclude that from the income statement. But grain on hand at the end of the year, even though it has not been sold, is part of the current year’s income picture, so place a value on that unsold grain and include it on the statement.
The same principle applies to a number of asset and liability item changes to make it a true picture of the current year. Adding those inventory changes to net cash income gives net operating profit.
The third part an income statement is depreciation on capital assets, which when subtracted from the net operating profit gives a true net farm income for the year. The income statement is used to determine profitability and efficiency ratios.
Cash flow projection. This is your operation’s financial plan for the coming year and usually includes personal income and expenses. The cash flow is used to determine the operation’s feasibility. Does your plan produce enough cash income to cover all expected cash outflows?
The cash flow projection does not determine true profitability. It is only looking at cash in and cash out. A farm or ranch can be profitable and not cash- flow (high family living costs, large principle payments on loan). Conversely the business can show a loss but still be able to cash flow (other outside income).
Other forms and statements may be particular to each lender, but most all the information will flow from these three basic financial statements. Learn the terminology. Understanding what they are, how they are generated and what they are used for will make for a more productive, informed relationship with your lender.
Visit ndfarmmanagement.com, or call 701-328-3162 for more information.
Armstrong is a North Dakota Farm Management Education Program instructor at Dakota College-Bottineau.
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