2.7 Financial Statement Analysis - Case Study

FINANCIAL STATEMENT ANALYSIS – CASE STUDY
BALANCE SHEET
 Shows financial condition of business at a specific point in time.
 A snapshot of:
o what is owned
o what is owed
o owner’s equity
o at a specific point in time.
 Strong balance sheet provides strong business foundation
 Balance Sheet: Relationship
o Assets = Liabilities + Net Worth Or
o Assets – Liabilities = Net Worth
 Assets - Everything owned or payable to the business
 Liabilities - All debt obligations owed
 Net worth or Owners Equity - Total assets minus total liabilities
 Useful to prepare balance sheet on the same date each year: January 1 or December 31 of
calendar year; OR Beginning or ending of fiscal year.
 Balance Sheet: Asset Valuation: Two common methods for assigning asset value:
o Current market value - Estimated amount the asset will sell for on the date of the statement minus
selling costs
 Cost - Original cost plus cost of improvements minus accumulated depreciation (Preferred)
BALANCE SHEET ANALYSIS:
1) LIQUIDITY - Ability of business to meet financial obligations when due.
a. Measured by:
i. Current Ratio
ii. Working Capital
iii. Working capital to gross revenue
b. Current Ratio: Current Assets/Current Liabilities = 3.21 - Current Ratio of 2:1 or better is a strong benchmark
c. Working Capital: Current Assets-Current Liabilities = $57,737
2) STRUCTURE - Are assets matched with liabilities? Where is the equity in the business?
a. High current debt to assets – Liquidity problems

b. High intermediate debt to assets – Capital replacement problems
c. High long term debt to assets - – Limited expansion capacity
3) SOLVENCY - Can business pay off all debts if all assets were liquidated? What is the Net worth? What is the ability to carry
more debt?
a. Measured by: They all use same data to measure the same thing; select one that makes sense to you and stick with it
i. Debt to Asset Ratio
ii. Equity to Asset Ratio
iii. Debt to Equity Ratio
b. Debt to Asset Ratio: Total Liabilities/Total Assets = 35%
4) Net Worth Change - Measures overall financial progress

a. Ending Net Worth – Beginning Net Worth = $58,302
INCOME STATEMENT
 Measures profitability of business in a given accounting period
 Shows income earned and expenses incurred during the accounting period
 Other names
o Profit and loss statement
o Operating statement
o Income and expense statement
 Most farm business income statements are for a calendar year
 Methods for preparation
o Cash – IRS Schedule F - Most farmers use cash income statements for tax purposes (conceals accurate profit picture
o Accrual - Accrual method provides true profit picture
o Accrual adjusted - Accrual adjusted method is good compromise
 Recognition of Income & Expenditures
o Cash Method Recognizes:
 Income when cash is received
 Expenditures when cash payments are made
o Accrual Method Recognizes:
 Income when it is earned
 Expenditures when incurred
 Inventory changes
o Accrual Adjusted Income Statement: Component Parts
 Cash farm income
 Cash operating expenses
 Inventory changes
 Depreciation expense
 Other Capital Adjustments
 Net Farm Income
INCOME STATEMENT ANALYSIS:
1) PROFITABILITY – Is the business making money?
a. Looks only at the farm business
b. Starts with accrual net farm income
c. Measures profits from the business against the resources used(returns on invested capital)
2) PROFITABILITY MEASURES
a. Net farm income from operations: Bottom line of the income statement
i. Flintstone Farms NFI = $62,835; Is a net farm income of $62,835 good or bad?
ii. Answer depends on many things, such as size of farm, Type of farm enterprises, Level of investment
iii.
b. Rate of return on assets: Net Farm Income + Farm Interest Paid ‐ Value of Operator’s Labor and Management/Total
Farm Assets = 8.1%. More than 8% is good.
c. Rate of return on equity: Net Farm Income ‐ Value of Operator’s Labor and Management/Total Farm Net Worth = 10%. More
than 10% is good.
d. Operating profit margin: Net Farm Income + Farm Interest Paid ‐ Value of Operators Labor and Management/Value of Farm
Production = 15.4%. Anything more than 25% is good
e. Asset turnover rate (efficiency measure): Value of Farm Production/Total Farm Assets = 52.3%. Anything more than
45% is good.

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FINANCIAL STATEMENT ANALYSIS – CASE STUDY

a. High current debt to assets – Liquidity problems

4) Net Worth Change - Measures overall financial progress

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