Agriculture Financing: Understanding the Basics of Your Financial Statements
Operators can benefit from a better understanding of their financial situation
By Clay Popko, Vice President, Vineyard & Winery Group, American AgCredit
You may know if your agricultural operation is making money or not, but do you know how profitable it is? For example, how much do you profit per acre of wine grapes? If you are unsure, you may want to utilize a balance sheet, a profit and loss statement (income statement), and a budget to help answer these questions.
The Balance Sheet
The balance sheet is a snapshot of an operation’s financial situation at a specific point in time, and it captures everything owed or owned. Balance sheets comprise assets, liabilities, and net worth (net worth is everything you own minus everything you owe).
Comparing a balance sheet from the beginning of the year to one at the end of the year will show how your business performed during that time period. It is important to note that you should maintain a consistent book value for your assets on the balance sheet rather than using market values, as market values are constantly changing due to market forces outside of your control.
On January 1, 2019, you purchase a 20-acre producing vineyard for $3,000,000. Upon the close of escrow, the market value is $3,000,000. At that point, the book value is $3,000,000 as well. This represents your total cumulative costs and expenses of your vineyard investment to that point in time.
During the year you sold 100 tons of fruit for $300,000 in gross revenue and had total farm operating expenses of $200,000, posting a gross profit of $100,000.
However, let’s also assume 10% appreciation in the value of the land (not unreasonable in today’s environment). So now, although no cash has changed hands, the value of your vineyard has gone up $300,000.
Book Basis: Your net worth is $3,100,000, the initial investment of $3,000,000 plus net income of $100,000. Keep in mind you will now have $100,000 in cash in your operating account.
Market Basis: Your net worth is $3,300,000, the current re-sell value of your vineyard, or perhaps $3,400,000 if a buyer insists they get your operating account in an acquisition.
Keep in mind that general success of your operation can affect the re-sell value, or market value. However, buyers of your business will insist on seeing book value results.
The Profit and Loss Statement
A second helpful resource is the profit and loss (P&L) statement, also known as an income statement. This is a running tally of all transactions in a given time period. When paired with the two balance sheets, a year-end P&L statement can be powerful. Balance sheets alone can indicate your profitability, but adding a profit and loss statement will pinpoint why your operation was profitable or not and help guide business decisions.
Your P&L statement shows above-average profitability, but on its own, it does not provide the full picture. When you pair your year-end balance sheet with the corresponding P&L statement, you might see that cash has increased more than your profit. This could be an indication that you are managing your accounts receivable more efficiently.
Understanding the basics of these financial statements allows you to control how and where money should flow in your operation.
Using a budget to plan around income and expenses can provide producers with increased awareness about buying and selling decisions. Producers can know when they need to prepay expenses or hold inventory. A budget can also help producers make decisions on whether or not they want to invest in a new piece of equipment, or if they can afford to buy a neighboring property, for example.
There are several “template” tools available to make budgeting easier. For example, you may consider using the Schedule F on your previous year’s tax return, which is also specific to your operation. It is also important to remember that the budget is a living document. Tracking income and expenses against your budget is a must, but don’t be afraid to adjust it when needed. New opportunities and obstacles will always pop up.
With a balance sheet, profit and loss statement, and a budget, you can become better prepared to move your operation into the future.
To learn more, contact American AgCredit at 800-800-4865 or visit us online at AgLoan.com.
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