SW Financial Literacy
I sometimes run into confusion when a farmer is working to update their balance sheet after a recent transaction.
Example 1: Putting together a year end balance sheet which includes old crop inventories. You order new crop seed, which has been received and paid for on the operating note. You also received and applied fertilizer for new crop, but this has not yet been paid for. How do we correctly show this?
Prepaid Expenses (Current Asset)
+$15,000 seed
+$22,000 fertilizer
Operating Loans (Current Liability)
+$15,000 seed
Accounts Payable (Current Liability)
+22,000 fertilizer
These balance out and there should be no change to your Net Worth after they are added.
Example 2: You buy a new tractor and pay for it entirely with cash. How is this shown?
Cash and Equivalents (Current Asset)
-$50,000 cash
Equipment (Noncurrent Asset)
+$50,000 tractor
There are no changes to the liabilities on your balance sheet since we paid cash. You can see how the Current Ratio decreased from 1.35:1 to 1.24:1 as the result of an all cash purchase. Again, no change to your Net Worth by making an all cash purchase.
Example 3: You want to buy 80 acres of farm ground. Purchase price would be $600,000 and you would like to finance $450,000 while making a $150,000 down payment. $450,000 financed over 25 years at 8.50% gives you payments of around $44,400/year. $38,780 of that first year payment goes toward interest while $5,620 is principal paydown.
Cash and Equivalents (Current Asset)
-$150,000 cash
Real Estate (Noncurrent Asset)
+$600,000 Ag land
Current Portion Term Debt (Current Liability)
+$5,620
Real Estate Loans (Noncurrent Asset)
+$444,380
Working capital decreases from $152,104 to -$3,516 as we need to factor in the first year principal payment under current liabilities. No change to Net Worth (Total Equity) as the adjustments are offsetting.
Hopefully this was a hypothetical situation and you haven’t signed the purchase agreement yet!
Have a great week!
Grant