What are Balance Sheets and Income Statements?

This blog will walk you through the basics of balance sheets and income statements – what are they and how can you use them.

What Are Balance Sheets and Income Statements?

• Balance Sheet - measures your current financial “health”.
• Income statement - shows how your financial health is trending.

These financial statements calculate ratios that measure how well your farm is doing financially. They also clearly list the assets and the liabilities of the operation, as well as how many families can be supported by the profitability of your farm.

Access Resources: Are you a Farm Credit of the Virginias Customer? Access balance sheet and income statement templates in the Recordkeeping section of the Member Portal.

What is a Balance Sheet?

A Balance Sheet lists the current market value of all your business assets as of that day. A balance sheet has an asset side and a liability side.

The Asset side of a balance sheet is usually divided into three sections: 

• Current Assets - assets you have on that day that will be used or converted to cash within the next year. These assets provide liquidity and are typically utilized for income generation. Examples include your checking & savings account balances, feed inventories, feeder livestock inventories, supplies, and prepaid expenses.
• Intermediate Assets - list the value of assets you will own and have a useful lives for 1-10 years. Examples include the value of your machinery and equipment inventory and the value of your breeding livestock.
• Long Term Assets - lists the current value of assets that you plan to own for more than 10 years. To make it easier, consider Long Term assets to be the value of your land and anything that is attached to the land.

Some balance sheets use two sections: Current Assets and Non-Current Assets. You can choose the format you like the best. 

The Liability side of the balance sheet is usually divided into three sections:

• Current Liabilities - lists the amount you owe someone else to be repaid within the next year. Examples include taxes payable, accrued expenses, credit card balances, operating loan balances, and the portion of your longer term loans that you will be paying within the next year (Current Portion of Term Debt). 
• Intermediate Liabilities - lists the amount you will owe on loans with a terms from 1-10 years. This is typically your machinery & equipment loans and your loans for breeding livestock. 
• Long Term Liabilities - the amount you owe on loans with a term of more than 10 years – typically your real estate loans.

The Equity section of the balance sheet shows how much ownership held in your asset base relative to what is owed. Your Equity (or Net Worth) in your farm is simply the value of your Total Assets minus the value of your Total Liabilities.

It is suggested that a balance sheet be built at the beginning of every year. This will allow you to track your financial growth over time. It will also help your financial professionals create “accrual-adjusted income statements” that show you the true profitability of your farm. Accrual adjustments help eliminate some cash basis transactions that may apply to the prior year or next year rather than the current calendar year. 

What is an Income Statement?

An Income Statement measures the profitability of your farm over the year it encompasses. The income statement consists of three sections:

• Revenues from the farm operations - lists the sale value of all the products you produced or services you provided throughout the year. This includes the receipts of all inventories sold during the year, such as crops and livestock. Other income such as custom hire, crop insurance, or ag program payments would also be included.
• Expenses related to the farm operations - lists the value of all expenses that were incurred for production that year. This will include items such as feed, seed, fertilizer, hired labor, and so on. It also includes the interest that you paid on loans that year, property taxes, insurance premiums, and a measure of the depreciation of your farm machinery and facilities. For depreciation, do not use tax depreciation because it is often inflated, instead, estimate the loss in market value of your assets caused by wear and tear and obsolescence, since last year.
• Net Farm Income for the year - is simply your Total Revenues minus your Total Expenses. You want your Net Farm Income to be positive, and hopefully growing each year.

There are 2 main forms of accounting that you can use for your income statement: 

• Cash-basis accounting
• Accrual-basis accounting.

Most farmers use cash-basis accounting for reporting their taxable income on the Schedule F. This is because cash-basis accounting allows you to make transactions that can reduce your taxable income. This includes:

• Prepaying operating expenses for next year
• Using the Section 179 bonus depreciation when you purchase farm equipment
• Deferring income to the next fiscal year

These moves can reduce your income taxes, but they provide an inaccurate measure of your true profitability. 

Accrual-basis accounting eliminates the year-end tax transactions to show a much more accurate picture of your farm’s profitability. Thus, it is recommended to utilize accrual income statements for long-term planning. The key to accrual accounting is to have beginning of year Balance sheets every year. Consultation with a financial professional is recommended for cash to accrual conversion.

Tips for Using the Balance Sheets and Income Statements

• Do a balance sheet at the beginning of every fiscal year. Try to do them around the same time period, say January 1 for a calendar fiscal year. 
• Be conservative, but realistic, in the valuation of your assets – stay on the low end of the market value range. For example, if you think your cattle are worth $1,200-$1,500/head, use the $1,200 figure. This builds in a little “worst case scenario” into your balance sheets. It’s really easy to make yourself look better on paper by increasing your asset values through market appreciation– avoid the temptation to do this.
• Work with your lender or accountant to make the accrual adjustments to your cash-basis income statement or Schedule F. This is relatively easy to do if you have your January 1 balance sheets.
• Use caution relying on your cash-basis Schedule F to make management or transition decisions! Remember, several of the items on a cash-basis Schedule F are artificial and it will not be representative of the true profitability of your farm.
• If your farm is owned by several entities (LLCs, etc.) or several people, build these financial statements for each individual or entity AND do a set of combined statements for the entire farm. For example, if you have one LLC that owns the land and the farm operations are handled under a different LLC, for your planning purposes combine the assets, liabilities, revenues and expenses for each entity to get a better picture of the entire farm operation.

Balance Sheets and Income Statements are important tools for the operation of your farm. Consult your accountant and/or lender to make sure these statements are representative of your farm. The better the financial information you have, the better long term decisions you can make!

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These materials are provided for educational and informational purposes only and do not constitute legal, financial, tax, or investment advice on any matter. We do not warrant that the materials provided are current and up-to-date with applicable laws and practices. You should not act or refrain from acting based on these materials or the information they contain without seeking legal advice from an attorney licensed in your jurisdiction or other appropriate professional. To the fullest extent provided by law, Farm Credit of the Virginias, ACA will not be liable for any loss or damage caused by your reliance on these materials or any information contained in these materials. Your use of the materials is at your own risk, and by accessing the materials, you hereby waive and hold harmless Farm Credit of the Virginias from any claims resulting therefrom.