April 28, 2023 | By: Payton Swinson |Agribusiness, Budgeting and Saving, Farming
Every business owner, from farmers to ag operators, wants a snapshot of the business’s financial performance at a glance. That’s where a balance sheet comes in; it’s a financial document that helps you evaluate the performance of your business at a given time.
If you’re unfamiliar with the ins and outs of this document, here are some balance sheet basics. This will help you better understand what a balance sheet is and how it’s a vital tool for any business owner.
What is a balance sheet?
The purpose of a balance sheet is to provide you with a snapshot of your business’s financial health at a specific time, showing what you own, what you owe, and the business’s net worth. It provides insights into three key categories:
Assets are owned by your business and have a cash value. Assets break down into two main categories:
- Current assets: These are assets that can convert into cash quickly, such as a business savings account, accounts receivable, inventory, supplies, crops or livestock for sale, and pre-paid expenses.
- Non-current assets: These are assets that take longer to become liquid and include land and property, livestock, machinery, long-term contracts, and retirement accounts.
List assets at the top of the balance sheet and in order of liquidity. So, current assets, including cash, start at the top and then go to the least liquid.
Depending on how your farm or agribusiness operates and how quickly you convert livestock or crops to cash or consumables, these may go into the current assets category. Working with an accountant can help you classify everything correctly.
Liabilities make up what your business owes, including debt, loans, and recurring expenses. As with assets, liabilities classify as current and non-current.
- Current liabilities: These are debts and obligations due within the next 12 months and can include accounts payable, taxes, rent or lease payments, credit card balances, salaries and other operating costs.
- Non-current liabilities: These are debts, loans, and expenses that have terms longer than one year, including loans for land, buildings, machinery and equipment.
On the balance sheet, current liabilities are typically listed first and by order of their respective due date, then non-current liabilities.
The third piece of the balance sheet is called owner’s equity. It’s a term that means the net worth of your business.
To determine owner’s equity, use an equation: Assets – Liabilities = Owner’s Equity.
If you’ve updated your balance sheet and see you have $5 million in assets and $3.75 million in liabilities, you have $1.25 million in owner’s equity. That’s the net worth of your business at that moment in time. Knowing this information can help make financial decisions, such as determining if you want to explore financing opportunities for new land or can pay with cash.
Owner’s equity is also called shareholder’s equity. For example, if your agribusiness is structured as an LLC with multiple partners, replace owner’s equity with shareholder’s equity.
What’s the purpose of a balance sheet?
A balance sheet gives you an idea of exactly how much your farm or ag business is worth at any time and gives you insight into how much debt or cash you have on hand.
A balance sheet is also a useful tool to help you run the business. For example, you may want to use it to:
- Assess your farm’s financial standing and overall health: For example, you may find larger liabilities than expected or have enough cash on hand to pay down debts to improve your credit score.
- Determine how your farm stacks up to competitors: This is a good place to review your financial habits and see how your business has performed over time.
Running the numbers on your balance sheet helps measure your operations’ liquidity and profitability (as well as potential solvency).
It’s essential to update your balance sheet consistently, such as quarterly or at the end of each year. That way, you’ll have the most accurate information to help you make decisions about your business.
Balance sheet vs. income statement: What’s the difference?
An income statement, also known as a profit and loss statement, is another important financial document that looks at assets, so you may wonder how the two compare.
Here are a few factors that go into understanding a balance sheet vs. income statement:
- Time: Unlike a balance sheet, which shows a snapshot of a moment in time, an income statement shows performance over time.
- Items listed: A balance sheet reports assets, liabilities, and owner’s equity, and an income statement reports revenue and expenses to help determine a company’s profit or loss.
- Selling vs. owning: An income statement shows a business’s goods, services, or product sales. A balance sheet shows the assets a company owns.
- Use: An income statement helps determine a business’s profitability, while a balance sheet focuses on financial obligations and the ability to meet them.
Both documents are essential to running business operations, but it’s also important to understand their differences. That way, you know which to look at and how each can help you make informed decisions for your farm or ag business.
Understanding balance sheet uses for farmers
A balance sheet is valuable for farms and agribusinesses — but you need to review it consistently.
Use it to compare how much cash you have to your liabilities to ensure you can meet your debts. And by reviewing balance sheets year-over-year or quarter-over-quarter, you’ll see how you’re growing or where you may need to cut back on expenses or ramp up production.
Understanding balance sheet basics can show you how your finances have changed over time, help you identify potential risks, and review your operations’ overall financial health.
Looking at the balance sheet from a lender’s perspective
An up-to-date balance sheet is critical if you’re looking for financing to expand your current operations or buy more land. So, if you’re planning on applying for a loan, you’ll want to take a hard look at your entire financial situation, including your balance sheet, from a lender’s perspective.
A balance sheet is one of many financial documents a lender looks at when determining if you’re a good candidate for a loan. As lenders review your documents, they’ll use the balance sheet to explore key numbers, such as your debt-to-income ratio, which compares monthly business income to debt payments.
Lenders also use your balance sheet to review your business levels of:
- Liquidity: The availability of your liquid assets and how much you have.
- Solvency: Your business’s ability to meet long-term financial obligations and debts.
- Risk: How risky your business may be to a lender, for example, if you struggle to pay debts.
In addition to your credit score and other financial documents, how these figures play out may impact the loan and the attractiveness of the terms.
Get comfortable with the balance sheet
Know that you’ve got a better idea about balance sheet basics, you can use that information to help you approach lending opportunities.
If you’re trying to determine how financing may help you expand or boost your farm or ag business, we’re here to help. Texas Farm Credit provides flexible financing options for farmers, agribusiness owners, and land investors.
To learn more, check out our resources section. Or get in touch for additional information on financing options.