Making sense in the information age

MARSHALL, Minn. -- Amazing strides have been made in crop, livestock and equipment efficiency since the new millennium.

Tremendous progress also has been made in computers, farm software, farm satellites and GPS. All are capable of generating mountains of paper information. We literally are in the "information age."

A business analysis can help you make sense of this information, if you have good records.

Base records

Establishing accurate base records now is critically important for analyses that will be done in the future. Three initial problems exist when creating base records: Beginning balances in accounting records often are incorrect. Knowledge seldom exists regarding accrued tax liabilities or how to enter them correctly. Accounting records are not available or they lack detail necessary to make sound management decisions.

Beginning balances consist of accurate quantities and values of the asset, liability and equity accounts on the first day of each year. These balances comprise the starting points for all financial analysis. Mixing fair market values with cost values (tax basis values) is common in analysis records. Both the market value and the cost value approach have their advantages and disadvantages.

Market value is useful to evaluate the actual solvency position of the business and to estimate actual net worth if all assets were liquidated. Most agricultural lenders use the market value to determine borrowing capacity and collateral positions. The weakness of the market value balance sheet is that it is difficult, if not impossible, to determine how much net worth change is a result of earned income and how much is a result of changes in asset value.

The cost value of an asset is the amount of cash paid for the asset less the amount of depreciation taken to date. A cost value balance sheet is useful to monitor progress over a period of time, since only changes in net worth resulting from earnings are included. Changes in net worth from changes in the value of land, etc., are not included. The weakness of the cost value balance sheet is that it does not clearly show the solvency position of the business for determining borrowing capacity and collateral values. For farm business analysis purposes, cost value balance sheets more accurately show progress resulting from earnings. Understanding the effects of these adjustments is crucial in today's business world.

Marketing errors

Another common accounting records error involves listing real estate at fair market value when the cost basis should reflect purchased, gifted or inherited basis. An additional mistake is to value machinery and vehicle loans at the lender's payoff balance instead of just the principal balance remaining.

Producers should remember that financial ratios utilize balance sheet data at both cost and fair market value, so ratios can be no more accurate than beginning balances.

Remember, "Garbage in, garbage out."

Let's get this year's records and analysis as accurate as possible to plan for the future. Your local farm business management instructor can help you construct a balance sheet. You can find an instructor in your area at www.mgt.org .

Editor's Note: Otto is a farm business management instructor with Minnesota West Community and Technical College in Marshall.