Dissect the digits on your balance sheet

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Numbers, numbers everywhere. They fill your waking hours and even invade your dreams. Somatic cell counts, ration formulations, cost of production, insurance premiums, milk production figures — the list goes on and on. And it seems like every expert wants you to dig into a different set of business digits.

Examining your balance sheet is no different. However, “Most producers really only need to examine three or four key areas from their balance sheet to help them determine the financial performance of their business,” says dairy business consultant Dan Wenzel, Wenzel Dairy Business Consulting, LLC, based in New London, Wis.  Changes in net worth, changes in accounts payable and changes in the operating loan balance go to the heart of the story.

Here’s how to use these three key indicators from your balance sheet to gain valuable insight into the financial performance of your business.

Indicator 1 

Changes in net worth.

What it is: 

Net worth is your ownership stake in the business.

How to calculate:

Total assets – total liabilities = net worth

Both of these numbers can be found on your current balance sheet.

What it tells you:

Net worth measures the financial position and well-being of your business at one point in time. To use net worth as an indicator, you must compare it against other periods of time to see if you are making progress. Generally, comparisons are made monthly and annually. 

Keep in mind that changes in net worth will differ, depending on which accounting method you use. If you use a cash-based method, you will see dramatic changes throughout the year, which can be misleading. For example, if you raise crops, then spring supplies will show up only as expenditures, and won’t appear as an asset until the crop is harvested.

However, if you use the accrual accounting method, those expenditures will appear immediately on the balance sheet as a corresponding asset, and net worth changes shouldn’t be as significant from one time period to another.

“This distinction is important because it explains how an operation can get into trouble if it does not monitor non-cash transactions,” says Mark Kapsner, dairy business analyst with Ag Star Financial Services in Mankato, Minn.

If net worth for the current year is higher, then you have increased your ownership stake in your business. As a double- check, be sure this change in net worth agrees with earnings from the income statement.

If net worth has decreased unexpectedly (not due to anticipated reduced business income), be sure to check your math and also make sure that nothing was omitted from the assets and liabilities used to make the calculation.

Likewise, if net worth is unexplainably higher, check these same areas. Also make sure you have properly credited owner capital draws and cash or asset infusions.

Your goal is to watch net worth trends over time so that you can best judge what is happening to your financial position.

Indicator 2 

Changes in accounts payable

What it is:

Accounts payable is the amount owed to creditors during the next 12 months.

How to calculate:

You will find accounts payable in the current liabilities section of your balance sheet.

What it tells you:

By tracking accounts payable — preferably monthly — you can tell if you are getting into a position where you will be unable to pay for goods and services received in a timely fashion. Changes in this area are one of the first things lenders look at to determine the health of your business.

“Whether a change in accounts payable is a concern or not depends on whether I see a corresponding change in another part of the balance sheet,” says Bruce Jones, dairy ag economist at the University of Wisconsin–Madison. “If I note an asset increase that goes hand-in-hand with a payable, I’m less apt to be concerned.” You have to look beyond the numbers to determine what caused the change.

In addition to making month-to-month comparisons, you’ll also want to make comparisons with the same month last year. This will show you if payables have increased or decreased over time.

If payables are on the rise, it could indicate a problem with cash flow, and it can be an early warning signal of problems ahead, cautions Jones. Or, it may indicate an inadequate line of operating credit to handle your production cycle.

However, sometimes a rise in payables reflects favorable terms from a supplier and is not a significant trend for your business. In this event, a bump in accounts payables may not necessarily be a bad thing — as long as the increase is justifiable, notes Kapsner.

Indicator 3 

Changes in operating loan balance

What it is:

Operating loans are short-term financial tools — generally one to three years — that help with immediate business needs.

How to calculate:

You will find this number on the liability side of the balance sheet. If your operating loan is for one year, you will find the balance under notes due within one year. If your operating loan is longer than one year, you will also need to include the balance from “notes payable” in the non-current portion to find the total value of the operating loan.

What it tells you:

Examining changes in your operating loan balance helps paint the picture of how well you’re able to repay borrowed money, while taking advantage of funds to purchase inputs or take advantage of discounts. To use this indicator, you’ll want to make comparisons from month to month and also against the previous year.

These loans should be paid down over time, and you want to be sure that is happening; otherwise, your short-term debt turns into long-term debt. At some point during the year, this balance should go to zero.

“If I look at operating loan balances and it equates to more than $300 per cow, then the dairy may be heading for trouble, especially if it has stayed at this level for a while,” predicts Wenzel. "The $300-per-cow thumb-rule also would include any past- due accounts."

When the operating loan is used to cover cash shortfalls, it decreases the amount of working capital available because there is no current asset to offset the increase in the loan balance, adds Kapsner. (For more on working capital, please see “How much working capital do you have?” from the March 2003 Dairy Herd Management.) When cash flow gets tight, producers generally expand the operating loan until they reach their credit limit, then supplier credit or credit cards are next in line.

If your operating loan is growing, check to see if funds have been used to purchase intermediate or long-term assets. Those assets should be refinanced on a longer-term loan in order to free up your operating line of credit to pay current bills and take advantage of cash discounts and special offers.

Putting it to work

Ultimately, you want these examinations to become second nature so that you can quickly spot trends and trouble spots. While you may prefer to make these comparisons annually, doing so will only limit your ability to respond to emerging trends. To really dig into your financial performance, you have to make the comparisons monthly.

“The balance sheet is the most important tool I use with my clients, even more so than the income statement,” concludes Wenzel. “It’s where we center our discussion, and it offers a teaching point of what’s going on in their business.”

Your balance sheet is a compilation of financial information from throughout your business. And it gives you a quick indication of whether or not your business is making progress, says Jones. And that’s something every producer must keep an eye on.



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