The Balance Sheet (2 of 2)

Know Your Numbers, Know Your Options Author

06/18/2020 Added

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By Austin Duerfeldt

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[00:00:00.248](upbeat music)
[00:00:08.550]So basic balance sheet is as previously mentioned,
[00:00:11.930]accounts for assets liabilities at their historical cost
[00:00:16.740]ignoring the market value.
[00:00:19.020]Some individuals will argue that it should also
[00:00:22.160]include market value as well.
[00:00:24.480]These operations often point to ease of calculation,
[00:00:27.970]true representation of the asset value
[00:00:31.930]and better evaluation of financial position and performance.
[00:00:36.380]The problem with market value
[00:00:38.290]is that it's difficult to estimate,
[00:00:40.260]it can cause large fluctuations
[00:00:42.740]from unrealized gains and losses.
[00:00:46.150]The concept of market value and cost basis
[00:00:49.620]is probably fairly recognizable.
[00:00:52.260]I purchased a new combiner three years ago for $400,000
[00:00:57.070]as my cost basis and is currently worth $290,000
[00:01:02.220]as my market value.
[00:01:04.140]In reality, valuation is much deeper than that.
[00:01:09.030]In agriculture there are four main common valuation methods.
[00:01:13.920]Equipment may use one valuation method,
[00:01:16.800]while stored grain we'll use another.
[00:01:19.620]Here are the four main valuation methods.
[00:01:23.640]Historical cost method.
[00:01:26.270]When dealing with an asset,
[00:01:27.820]it is the amount of cash or cash equivalent
[00:01:30.610]paid to acquire the item
[00:01:33.000]and adjusted for depreciation or other allocations.
[00:01:37.850]The amount of cash or cash equivalent paid,
[00:01:40.280]should include all costs to get it up
[00:01:42.610]and operational in this intended use.
[00:01:46.090]So if I go out and purchase a green bin from a dealer,
[00:01:50.170]the cost should include the concrete,
[00:01:52.670]to labor and the shipping,
[00:01:55.050]not just the amount paid to the dealer for the green bin.
[00:02:00.660]The current market valuation method,
[00:02:03.310]is another one that I would say is fairly easy
[00:02:06.950]for most to understand and recognize.
[00:02:10.020]That is to say amount of cash or cash equivalent
[00:02:12.860]that can be obtained by liquidation.
[00:02:15.760]Going back to that combiner I had mentioned earlier,
[00:02:18.950]we said that it was worth $290,000 based on current markets.
[00:02:25.130]That would be our current market valuation
[00:02:27.600]for that piece of equipment.
[00:02:31.260]Taking that one step further though,
[00:02:33.030]there is what's called the net realizable value method.
[00:02:36.580]And that's the amount of cash cash equivalent
[00:02:39.420]an asset is expected to be converted to
[00:02:42.020]in the due course of business,
[00:02:44.020]plus any direct costs necessary to make that conversion.
[00:02:48.090]So I might've mentioned our market value
[00:02:51.610]of the combiner being $290,000,
[00:02:55.260]but let's say that I sold that on an auction.
[00:02:58.570]Well, I've a delivery cost to get it to the auction.
[00:03:01.250]I also have to pay the auctioneer,
[00:03:04.150]their percentage for the sale.
[00:03:06.300]And so my net realizable value
[00:03:08.180]is going to be less than that 290,000.
[00:03:10.360]Let's say that by the time I paid the percentage
[00:03:12.410]and the delivery, I ended up with $287,000.
[00:03:19.890]The final method is the discount future cash flows method.
[00:03:24.520]When dealing with an asset,
[00:03:26.420]the present value of future cash inflows into which an asset
[00:03:30.620]is expected to be converted in the due course of business,
[00:03:34.000]plus any present value of cash outflows
[00:03:37.460]necessary to attain the influence.
[00:03:41.700]That may sound extremely complicated,
[00:03:45.090]again though it's a situation
[00:03:46.920]of when we're looking at loans or something of that nature,
[00:03:51.660]we're looking at how much
[00:03:53.770]is it going to cost me to get the asset
[00:03:56.980]and what inflows am I expected to see from it.
[00:04:01.540]The determination of which method should be determined
[00:04:05.750]through the nature of the item, relevance and reliability.
[00:04:12.100]For something to be relevant,
[00:04:14.210]information must have feedback value, predictive value
[00:04:18.390]and it should be timely.
[00:04:20.879]Reliability dictates that information
[00:04:23.917]must be representationally faithful, verifiable and neutral.
[00:04:32.680]The Farm Financial Standard Council has some recommendations
[00:04:36.250]on different assets and the valuation method
[00:04:40.310]that they see as the most relevant way to go about it.
[00:04:46.690]We will try and include some of those more commonly ones,
[00:04:50.290]but again this would be one of those sections
[00:04:52.330]where I would recommend that
[00:04:53.850]if you're getting into this type of conversation,
[00:04:57.250]this type of record keeping,
[00:04:59.760]thinking about buying that document
[00:05:01.830]from Farm Financial Standard Council would be
[00:05:07.400]a good idea.
[00:05:13.100]So we've been talking about valuation methods.
[00:05:15.740]Now I think we need to talk a little bit about something
[00:05:18.180]that goes into a little bit deeper of a concept.
[00:05:23.340]What do we do about inventory?
[00:05:26.400]Earlier We had mentioned inventory
[00:05:28.070]uses lower of cost market.
[00:05:31.250]The market side is simple enough to come up with.
[00:05:35.340]But how do I calculate the cost?
[00:05:38.460]For example, what is the cost of a ration mix
[00:05:42.070]that I have for cattle at the end of the year?
[00:05:45.090]It gets taken from an attitude weekly
[00:05:47.510]and the price varies each time that I add to it.
[00:05:51.170]How would want to count for the value of that pile?
[00:05:55.170]Actual cost of the remainder,
[00:05:57.150]is going to be difficult to acquire.
[00:05:59.800]So to the rescue comes LIFO, FIFO and weighted average.
[00:06:04.930]And before you ask if those are the names
[00:06:06.620]of my pet dogs, they are not.
[00:06:09.570]What those stand for are the last in first out,
[00:06:12.980]first in first out and weighted average
[00:06:15.670]inventory valuation methods.
[00:06:18.350]Here are a breakdown of each.
[00:06:21.420]LIFO or last in first out states that,
[00:06:25.200]we expend the most recent purchase first.
[00:06:28.930]Say that we bought a 100 bushels of grain
[00:06:31.450]in January for $3.20
[00:06:34.680]and another 200 bushels of grain
[00:06:37.020]in March for $3.50.
[00:06:40.300]If in April I feed 150 bushel of grain,
[00:06:44.180]I fed out 150 bushel valued at $3.50 a bushel,
[00:06:49.280]according to LIFO or $525.
[00:06:54.099]The remaining pile of 150 bushels has a value of $495,
[00:07:00.500]100 bushels at $3.20 and 50 bushels at $3.50.
[00:07:07.840]The FIFO method is first in first out,
[00:07:12.780]or basically we're expensing it out
[00:07:15.240]in the order it was purchased.
[00:07:17.640]So using the same example,
[00:07:20.000]with the grain bought in January and March,
[00:07:23.020]with FIFO the April fed to cattle
[00:07:26.140]would be $495 due to using all of the 100 bushels
[00:07:30.860]in January and 50 bushels for March.
[00:07:35.290]The remaining pile has a value of $525.
[00:07:41.170]Weighted average is the last of the three.
[00:07:44.790]And what it does is it takes a total quantity
[00:07:47.730]and the total price paid and calculates an average cost.
[00:07:52.150]Again, using the example, we have a total of 300 bushels
[00:07:57.700]that we paid $1,020 for.
[00:08:03.360]1020 divided by 300 gives us an average of $3.40.
[00:08:09.770]That means that the fed grain was valued at $510.
[00:08:17.130]You might've already started to catch
[00:08:19.720]that this is an important feature.
[00:08:22.200]Depending on how we value our cost of production,
[00:08:27.990]the price that we look to sell can be different
[00:08:32.010]Under LIFO I fed the cattle $525 worth of feed,
[00:08:36.970]but under weighted average, the feed was only worth $510.
[00:08:41.490]And still FIFO says I only fed out $495 to the cattle.
[00:08:47.460]Here falls an important stands to be consistent
[00:08:51.200]within your operation
[00:08:52.830]and to follow industry standards whenever possible.
[00:08:57.100]By doing so you'll be setting yourself
[00:09:00.450]for up to easily benchmark yourself to other operations.
[00:09:06.110]So this should give you a basic idea
[00:09:08.520]of what the balance sheet is,
[00:09:10.620]it's different sections,
[00:09:12.300]and how we should go about thinking and calculating each
[00:09:15.910]of the individual portions of that balance sheet.
[00:09:19.720]For the next section, what we gonna do is
[00:09:21.270]we gonna talk about the financial ratios
[00:09:23.730]that we specifically calculate through the balance sheet
[00:09:26.890]and how to interpret those ratios
[00:09:29.220]so that we can benchmark ourselves
[00:09:30.940]not only to other operations throughout the state
[00:09:34.380]or through the Midwest,
[00:09:36.060]but also how we can use those numbers to compare ourselves
[00:09:39.320]to how we've been doing from say the past year,
[00:09:42.150]the past three years, past five years
[00:09:44.390]in order to make sure that we're still working towards
[00:09:47.960]improving our operation to the best of our ability.
[00:09:52.240](upbeat music)

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The Balance Sheet (2 of 2)

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