A balance sheet is a document that records the value of all farm business assets and liabilities at a point in time. The financial document can also be referred to as a financial statement of equity and net worth. Balance sheet preparation is a standard operative procedure for many farm businesses. The farm business comprises “assets” such as land, buildings, machinery, cattle, savings, and cash.
The assets that have claims upon them by loan lenders, dealers, cooperatives, etc., are known as liabilities. The farm owners also claim the assets, known as net worth or equity. The sum of the net worth and liabilities, or the value of the farm assets balance, creates the conceptual structure of the balance sheet.
Why Farmers Need to Maintain a Balance Sheet
Balance sheets are essential for a variety of reasons. They reflect critical financial information used in commercial transactions. Some of the major reasons to maintain a balance sheet for your farm include the following:
Help Evaluate Risk and Return
A balance sheet consolidates all of your farm’s assets and liabilities into one document. Your ability to earn cash and sustain operations is reflected in your current and long-term assets. Your financial commitments are prioritized by your short- and long-term debts. Your assets should outnumber your liabilities, suggesting a positive net worth. If your present liabilities exceed your cash balance, your company will need more farm capital from investors or lenders. When debt becomes unsustainable, a balance sheet can help farmers disclose this.
Secure Loans and Investors
People can immediately understand your company’s financial situation thanks to a well-detailed balance sheet. Most lenders demand a balance sheet to assess a company’s financial health and creditworthiness. If you request a farm loan, your financial statements might show lenders that you will likely repay your bills on time. In addition, balance sheets help potential lenders or investors understand where their money will be used and when they can expect a return on their investment.
Make Long-Term Business Decisions
Tracking your farm’s finances can assist you in identifying possible concerns before they become serious issues. For instance, most farms fail due to cash flow issues, which can be discovered and improved early if accurate and up-to-date balance sheets are accurate. Farm businesses often misunderstand the importance of budgeting, overspend on expenditures, and delay seeking loans for too long. These common financial issues can be addressed by developing an effective business plan and using financial statements to drive business decisions.
Prevent Potential Problems
The major motivation for starting a business is to make money. Therefore, a well-run business should accumulate equity. If your company isn’t doing so, examining certain assets and liabilities on your balance sheet will help you figure out why. For instance, if most of your assets are in inventory, you may expose yourself to undue danger. Unsold inventory can easily become a major liability.
Make Tax Preparation Easier
Maintaining a proper balance sheet is essential for tax preparation and planning. The IRS recommends that farm businesses keep organized and up-to-date financial records to submit correct tax returns. Your tax preparer will be able to properly prepare your tax returns and ensure that you don’t pay more taxes than necessary if your financial accounts are in order. In the event of an IRS audit, you will be expected to produce a complete set of financial documents, including financial statements, for review.
When to Prepare Farm Balance Sheet
The period at which a farmer prepares a current balance sheet is determined by the degree of change in income and expense flow, the volatility of asset prices, and the size of the farm. Intervals might range from one month, quarterly, semi-annually, to one year. Many farmers like to prepare a balance sheet once a year. There is no correct or incorrect time of year to prepare one. The balance sheet is frequently constructed after farm production has been sold or when inventory is at its lowest point, allowing for less doubt about the value of produce or livestock.
However, the financial statements must be prepared on or around the same day each year. This provides the best opportunity to compare change over time, which is one of the most valuable qualities of the document. The multiple balance sheets generated around the same time each year can reveal the farm business’s financial change over time.
Suppose a farmer relies on their tax return rather than a balance sheet to determine how their business performed financially during the reporting period. In that case, the underlying facts may be too long for the farm owner to make wise management decisions to survive the bad times.
How to Prepare a Farm Balance Sheet
A balance sheet can be prepared in two ways: on a market basis or a cost-basis approach. Each approach has its advantages and disadvantages. If a farmer works with a certified public accountant (CPA), it will frequently use the cost basis, which comprises all assets valued at cost with a deduction for accumulated depreciation. Before determining net worth or equity, an incurred tax obligation is normally included in the liability column.
Many sole proprietorships generate balance sheets using market values. The values of the assets mentioned are an approximation of their market worth. This is usually not an issue with financial assets like savings, checking, or investment accounts. However, it might pose a problem for assets whose market valuations are difficult to determine. An estimate of income tax payable is often omitted, which would be a liability because their market value is more than the tax base in many assets.
Maintaining Your Balance Sheet for Your Farm
Preparing a balance statement regularly is a crucial health check for any farming business. Once the farm has a healthy balance sheet, you can determine whether you need to look for measures to strengthen your financial position and refinance debt, among other things. In addition, the farm can see the change in net worth from year to year if a balance sheet is made each year. A lucrative year normally raises net worth, whereas an unproductive year may necessitate deteriorating farm net worth and “burning equity.”