AGEC 3403 - Chapter 2.1

Statement of Owners Equity

-The FFSC recommends that a statement of owners equity be part of a complete set of financial records -The statement shows the sources of change in owner equity over the accounting period

Debt to Equity Ratio (Solvency Measures )

-This ratio is called the leverage ratio -Total Liabilities/Total Equity -When it is 1.0 lenders and owners are providing an equal portion of financing -Smaller is better and it will approach zero as liabilities approaches zero

Debt to Asset Ratio (Solvency Measures )

-Total Liabilities/Total Assets -Ratios greater than 1.0 indicate insolvency

Net Working Capital (Liquidity Measures)

-Working Capital = Current Liabilities - Current Assets -Essentially represents the amount of cash available after accounting for what is owed this accounting period -If the value is positive (current assets are greater that current liabilities) then the company is liquid

Assets

-an asset has value for one of two reasons: 1. it can be sold to generate cash or 2. it can be used to produce other goods that in turn can be sold for cash in the future

Balance Sheet Format

-arranged to reflect what would happen if a business ended that day -->if it sold all its assets -->paid off all its debts -to do this we separate things into categories -Assets shown on the left (current assets on top, non-current on bottom) -Liabilities are shown on the right (current liabilities on top, non-current on bottom) -Owners equity shown on balance sheet and liabilities plus owners equity equals assets.

Snapshot(Balance Sheet)

-how the business looks at a point in time or a given day -Financial condition of the business on one specific date and only on that date -health of business may be very different at a different date -ex: row crops - prepared at least once per year

Cost-Basis Vs. Market-Basis

-A cost-basis balance sheet has all assets valued following the cost, cost less depreciation, or farm production cost methods. The one exception would be inventories of grain and market livestock -A market-basis balance sheet has all assets valued at market value less estimated selling costs

Current Liabilities

-Accounting principle that current liabilities be separated from other liabilities on the balance sheet -CL are financial obligations that will become due and payable witin one year from the date on the balance sheet -Ex: accounts payable, principles an accrued interest on short-term loans, and principal due within one year on long term loans

Lower of cost or market (Asset Valuation)

- Conservative method

Equity to Asset Ratio (Solvency Measures )

- Total Equity/Total Assets -The higher the number the better, but cant possibly exceed 1.0

Liablities

- is an obligation or debt owed to someone else -it represents an outsiders claim on a business

Maturity Matching

-Accounting principle that demans an asset must be financed with a liability similar in length to the usefull life of an asset -So, if you purchase a truck with a useful life of 8 years, it should be bought with an eight year loan -Visually represents on balance sheet by putting current items on top and non-current items on bottom -Assets should be nearly side-by-side with their corresponding liabilities

Farm Production Cost (Asset Valuation)

-Accumulated cost of producing the item (immature crops growing in field, livestock)

Non-Current Liabilities

-Any liability that is not current is classified as a noncurrent liability -these financial obligations will become due and payable some time after one year from the date on the balance sheet

Long Term Liabilities

-Are due after 10 years

Intermediate Liabilities

-Are due and payable after 1 year but before 10 years

Intermediate Assets

-Are expected to have a life of 1 to 10

Current Assets

-Assets can be sold easily to generate cash are called liquid assets -Accounting principles require current assets, high are the more liquid assets, to be be separated from other assets on the balance sheet -Current Assets include: Cash, marketable stocks and bonds, accounts receivable, and inventories of feed, grain, supplies and feeder livestock

Balance sheet equation

-Assets equals liabilities plus overs equity A=L+OE -another configuration: L=A-OE

Why set up balance sheet this way?

-Assets on the left, liabilities and OE on the right -If done correctly, the left and right columns will "balance"

Non-Current Assets

-Assets that are not current assets are classifies as non-current assets. They are more difficult to sell and/or their sale would be more likely to disrupt the business -Their sale is not the primary function or operation for the company, so what is a non-current asset could depend on the type of firm in question -non-current assets for a farm include: equipment, machinery, breeding livestock, buildings and land -A tractor dealership would have tractors has inventory.

Balance Sheet Example

-Assets: Most differences show up in valuation of concurrent assets -Liabilities: little differences in liabilities sections, other than deferred taxes -Owners Equity: Valuation adjustments on market-basis balance sheet accounts for change in assets worth over time because of changes in market conditions for item.

Asset Valuation

-Before constructing a balance sheet, it is often necessary to establish the value of assets -Several valuation methods can be used and the choice depends on the type of assets that the purpose of the valuation

Book Value (Asset Valuation)

-Cost less accumulated depreciation

Which is method is best? (Cost-Basis Vs. Market-Basis)

-Cost-basis balance sheets conform to general accounting standards and are this comparable to balance sheets from other types o businesses -Market-basis balance sheets more accurately reflect the actual financial position -FFSC says both types of balance sheets are needed for proper business analysis

Liquidity Measures

-Current Ratio -Net Working Capital

Solvency Measures

-Debt/asset ratio -Equity/asset ratio -Debt/equity ratio (leverage ratio)

Current Ratio (Liquidity Measures)

-Equals the current asset value divided by the current liability -Values greater than 1.0 are preferred -CA/CL

Market Value (Asset Valuation)

-Fair market price less any transactions cost (for items normally sold)

Cost (Asset Valuation)

-For purchased items that do not normally lose value

Fixed Assets

-Have a useful life of more than 10 years

Owners Equity

-If an asset were to be sold and all debts paid on the date of th balance sheet, the owners equity would be the amount left over -OE changes when: 1. the business ha a profit or loss 2. the owner invests more capital from outside the business or withdraws money form the business 3. assets change value -OE does not change when cash is used to buy other assets or a loan it taken out to purchase an asset with value equal to the loan

Liquidity

-Measures the ability of the business to meet financial obligations as they come due without disrupting the normal operations of the business -Liquidity measures the ability to generate cash needed to pay obligations -Liquidity is generally measures over the next accounting periods and is a SHORT-RUN concept

Solvency

-Measures the liabilities of the business related to the amount of owners equity in vested in the business -It provides an indication of the ability to pay iff all financial obligations or liabilities if all assets were sold -if assets are not greater than liabilities, the business is INSOLVENT

Assets and Liabilities Further Defined

-More complex balance sheet separates non-current items into intermediate and fixed categories -

Other Measures

-Net capital is found by dividing total assets by total liabilities -The debt structure ratio is found by dividing current liabilities by total liabilities (shows what percent of debt is currently due)

Statement of Owners Equity, what is included

-Paid-in Capital: -->Beginning balance -->Common stock issues -->Additional paid-in capital -->Ending Balances -Retained Earning: -->Beginning Balance -->Net income for the year -->Less: Cash dividends -->Ending balance -Total Owners Equity

Purpose and use of a balance Sheet

-Systematic organization of everything "owned" and "owed" Assets equal liabilities plus owner equity -Owner equity equals assets minus liabilities -Can complete at any time, but most prepared at end of accounting period -Provides measures of solvency and liquidity

Valuation of raised breeding livestock (Cost-Basis Vs. Market-Basis)

-the FFSC recommends either the "full-cost absorption" method or the "base value" approach -Under full-cost absorption all the costs of raising breeding livestock are accumulated over time until the animal reaches its current status. -Under the "base value" method, the producer uses a specific value that remains relatively fixed over time so that changes in the value of breeding stock reflect changes in the number of animals

Owners Equity (Continued)

-the leftovers after subtracting liabilities form assets is called OE -If there would be money left over (Solvent-positive OE) -The there would be no money left over (Insolvent - negative OE) -