Basic Financial Statements for Business Control

1. Basic Financial Statements for Business Control • Financial statements allow mgers know the firm’s performance in reaching its financial goals of profitability & healthy financialconditions. • There are two main financial statements. • 1. Balance Sheet:It summarizes the financial condition of the business at a point in time. Its purpose is estimate net worth or owner's equity by valuing assets & liabilities • 2. Profit & loss or Income Statement: It summarizes those financial transactions that affected revenue & expenses over a period of time. The purpose of an income statement is to provide an estimate of net farm income or profit. • Note: While intended for different purposes, there is a key relationship, or connection, btwn the 2 financial statements cos most transactions affect both balance sheet & income statement.

2. The Balance Sheet and Its Analysis • Objectives are • 1. To discuss the purpose of a balance sheet • 2. To illustrate the format & structure of a balance sheet • 3. To outline the problems & procedures for valuing assets • 4. To show differences btwn cost & mkt basis balance sheet • 5. To define owner's equity or net worth & show its importance

3. Purpose And Use Of A Balance Sheet' • A balance sheet is an organization of everything "owned" & "owes' by a business or individual at a given point in time. • Asset: Anything of value owned by a business or individual is called an asset. • Liability: Any debt or other financial obligation owed to someone else is referred to as a liability. • Thus, a balance sheet lists assets & liabilities & a difference or balance being an estimate of net worth or owner's equity. • Net Worth or Owner's Equity: Is the difference btwn total assets & total liabilities. The "balance" in balance sheet is the requirement that the ledger be in balance through the basic accounting equation of • Assets = liabilities + owner's equity • This allows finding owner's equity once assets & liabilities are known: Owner's equity = assets - liabilities

4. Analysis & Comparisons of Financial Conditions: Balance sheets are used to compare and analyze financial conditions of firms of one period to another. Thus it can be completed any time during an accounting period. But most of them are prepared at the end of an accounting period, usually on December 31 for most firms. • This procedure allows a single balance sheet to be both an end of the year for one accounting period and a beginning of the year statement for the next accounting period. of the year statement for the next accounting period. • Measure Financial Position of a Firm at a Point in Time: Is done primarily through the use of 2 concepts. • 1. Solvency:Measures firm’s liabilities relative to amount of owner's equity invested in the firm. It indicates the ability to pay off all financial debts or liabilities if all assets were sold – i.e. assets are greater than liabilities. If assets are not greater than liabilities, the firm is insolvent or bankrupt.

5. 2. Liquidity:Measures ability of the firm to meet financial obligations as they come due without disrupting the normal operations of the business. • It also measures ability to generate needed cash & at the time it is needed. These cash requirements & possible sources of cash are generally measured only over the next accounting period, making liquidity a short-run concept. • Balance Sheet Format • A BS shows assets at top & liabilities below assets • Current assets xxx • Non-current assets xxx • Total assets xxx • Current liabilities xxx • Non-current liabilities xxx • Total liabilities xxx • Owner Equity xxx • Total liabilities & Owners Equity xxx

6. Balance Sheet AgBiz Corporation December 31, 19 • Current assets: Cash $ 17,000 • Accounts receivable 30,000 • Inventories 127,000 • Total current assets $ 174,000 • Fixed assets: Land 250,000 • Buildings and equipment 660,000 • Less allowance for depreciation 170,000 • Total fixed assets 740,000 • Other investments: Cash value of life insurance 6,600 • Investment in stock in other firms 24,400 • Investment in subsidiary 75,000 • Total other investments 106,000 • Total assets 1,020,000 • Current liabilities: Accounts & notes payable $53,000 • Accrued taxes payable 1,750 • Installments due this year on long-term debt 35,200 • Total current liabilities 89,950 • Long-term liabilities:Long-term notes payable 320,050 • Total liabilities 410,000 • Owners' equity: Capital stock 390,500 • Retained earnings, January 1 177,200 • Net income for the year 42,300 • Retained earnings, December 31 219,500 • Total owners' equity 610,000 • Total liabilities and owners' equity $1,020,000

7. Assets: An asset has value for two reasons. • 1st , it can be sold to generate cash or, • 2nd , it can be used to produce other goods that in turn can be sold for cash at some future time. • Liquid Assets: Goods that have already been produced, e.g. grain can be sold quickly & easily without disrupting future pdn activities • Illiquid or Less Liquid Assets: Assets like land, machinery, breeding livestock, are used to produce other pdts but are difficult to sell quickly & easily at their full market value for cash income as it will affect the firm’s ability to produce future income. • Tangible & Intangible Assets: Tangible assets include inventory or equipments, intangible assets include patents or “goodwill” associated with firm’s past performance.

8. 1. Current Assets:Are more liquid assets, will either be used up or sold within the next yr as part of normal business activities. Cash on hand, checking/savings account balances are current assets & are the most liquid of all assets. Others include marketable stocks & bonds, accounts receivable, & feed inventories, grain, & feeder livestock (held primarily for sale & not for breeding) • The level of current assets measures firm's ability to pay its bills in the coming accounting period. • Cash. Cash is considered a current asset since it can be used immediately. • Accounts Receivable. Are debts owed to the firm from sales made on credit that are expected to be paid/received during coming accounting period (i.e a year or less). • Inventories. Are goods expected to be sold during coming business year. They include finished goods ready for sale, goods in process, such as growing plants or grain in storage that will be made into feed.

9. Non-current or Fixed Assets:Include buildings, eqpt, land, & breeding livestock. These assets provide benefits to the firm for a period greater than one accounting period & their value diminishes as they wear or depreciate (except land). • They are recorded at their acquisition cost less depreciation taken or plus appreciation. • Other Investments. Includes investments made outside the normal transactions of the firm e.g. cash value of life insurance a firm maintains on some employees, stock investments in other firms. Assets are grouped this way to show which are invested in the firm's primary business & which pertain to other ventures.

10. Liabilities and Owners' Equity • This section of balance sheet shows there are two groups of people who can make claims against the assets of the business- creditors & owners (or stockholders). • Creditors 1st: Are legally entitled to the first claim; • Owners 2nd: The balance that remains is owners' equity. • Total claims of creditors & owners must equal the total value of assets. Hence, Assets = liabilities + owners' equity • If Liabilities > Assets, owners' equity = -ve, & the firm will be insolvent, & it could file for bankruptcy.

11. Liabilities:A liability is an obligation or debt owed to someone else. It represents an outsider's claim against one or more of the business assets. They are classified as current or long-term. • Current Liabilities: These are financial obligations that will become due and payable within the accounting period & will thus require cash be available in these amounts within the next year –e.g. accounts payable, principal & interest on long-term debt that is due within the next accounting period, taxes payable etc. • Non-current or Long-term Liabilities: These include all obligations that do not have to be paid in full within the next year – e.g. long-term notes & contracts on land, buildings & eqpt, less principal & interest due within the accounting period. i.e. any principal due within the next year is shown as current liability, & remaining balance on the debt is listed as a non-current liability.

12. Owners' equity or net worth: Represents money left for owner of the business shld the assets be sold & all liabilities paid as of the date of the balance sheet. Owners’ equity can be found by subtracting total liabilities from total assets & is thus the "balancing" amount, which causes total assets to exactly equal total liabilities plus owners’ equity. It’s the owner’s current investment or equity in the firm. • Changes In Owner's Equity: • Using Profits to Purchase Assets: Using assets in pdn provides profits & when the profit is used to purchase additional assets or to reduce liabilities the owner’s equity changes. • Gifts or Sale of Assets: Owner's equity will also change if there is a change in an asset's value, a gift or inheritance is received, or an asset is sold for more or less than its balance sheet value. • Assets value appreciation: Changes in asset values due to inflation or disinflation affect equity if assets are valued at mkt value • If owner puts into or withdraws capital from the firm, or when the business shows a profit or loss

13. Profit & Loss or Income or Operating Statement • Its a summary of revenue & expenses for a given accounting period. • Purpose: It measures the difference btwn revenue & expenses. If revenue exceeds expenses there is a profit, & if expenses are greater than revenue there is a loss. • Thus it answers the question: Did the farm or ranch business have a profit or loss last year & how large was it?

14. Income or P&L Statement Format • In very condensed form the structure is • Total Revenue xxx • Less Cost of Goods sold Beginning Inventory xxx Plus Goods purchased xxx Cost of Goods available for sale xxx Less Ending Inventory xxxTotal cost of goods sold xxx • Gross Profit or Margin xxx • Less Total Operating Expenses xxx • Income or Profit from Operations before taxes xxx • Plus or minus gain/loss on sale of capital assets xxx • Less income taxes xxx • Equals net farm income xxx

15. Profit/Loss Statement AgBiz Corpn for Yr Ending Dec 31, • Revenue from sales $1,465,000 • Less: Cost of goods sold • Inventory, January 1 $ 151,000 • Plus: Goods purchased 1,105,000 • Cost of goods available for sale 1,256,000 • Less: Inventory, Dec. 31 127,000 • Total cost of goods sold 1,129,000 • Gross margin 336,000 • Less: Operating expenses • Salaries and wages 140,000 • Office expenses 3,400 • Selling and promotion 72,000 • Utilities and fuel 44,600 • Rent 5,000 • Depreciation 20,000 • Total operating expenses 285,000 • Income before taxes 51,000 • Allowances for income taxes 8,700 • Net income (to retained earnings) $ 42,300

16. Revenue: Is the 1st item on the P&L statement. It refers to goods sold or services provided in cash or on credit (i.e. amount received or to be received – accounts receivables). • Less Cost of Goods Sold: It’s the 2nd on the P&L statement. It represents the direct costs to the firm to goods purchased or manufacture that were sold to generate the revenue. • It is calculated as follows (hypothetical): • Beginning inventory $100 • Plus Goods purchased + 300 • Goods available for sale 400 • Less Ending inventory - 50 • Cost of goods sold $350 • Gross Margin or Profit: Its the subtraction of cost of goods sold from revenue. It shows income that remains to cover the expenses of selling the pdt & administering the business.

17. Operating Expenses/Overhead: It’s the costs of operating & administering the business. It includes cash & non-cash (payable) expenses. • Cash Expenses:Include salaries, rent, utilities, repairs etc. • Non-cash Expenses: Include depreciation, accounts payable, accrued interest & other accrued expenses. There is also an adjustment for prepaid expenses – i.e. cash expenses are adjusted for accounts payable & prepaid expenses • Subtracting operating expenses from the gross margin figure gives the profit for the period. • Net Income:Is the "bottom line“. It’s the amount by which revenue exceeds expenses (i.e. profit) plus any gain or loss on the sale of capital assets less taxes. Its the profits after income taxes have been paid. It is then reported on the balance sheet as the change in retained earnings.