Practical on Preparation of Balance Sheet

ANALYSIS OF NET WORTH STATEMENT / BALANCE SHEET

Introduction
Various tools of financial analysis i.e. Net Worth Statement (Balance Sheet), Income
Statement, Cash Flow Statement, Break-even Analysis etc. are used to assess the
performance of the farm business.
Balance Sheet or Net Worth Statement
It is a statement of the financial position of a farm business at a particular time,
showing its assets, liabilities and equity.
If the assets are more than the liabilities it is called net worth or equity and its
converse is known as net deficit.
The typical balance sheet shows assets on the left hand side and liabilities & equity
on the right hand side. Both sides are always in balance hence the name balance sheet.
Importance of Balance Sheet
● It explains financial position of the farm business at any point of time.
● It shows solvency (do assets exceed liabilities?)
● It measures liquidity (will firm meet financial obligations?)
● It helps to study the performance of farm business over the years. If the net worth
increases over the time indicates efficient performance of the farm business.
Important Terminology
Assets : Are those which are owned by the farmer. Types of assets are as under:
1. Current Assets (Short term Assets): It can be converted into cash within a short
time i.e. usually one year. E.g. cash on hand, farm produce ready for disposal, etc.
2. Intermediate Assets (Working Assets): Less liquid than the current assets. E.g.
machinery, equipment, livestock, tractor, etc.
3. Long term Assets: (Fixed Assets): An asset that is permanent or will be used
continuously for several years. E.g. land, farm building, etc.
Liabilities: It refers to all things, which are owned to others by the farmer. Types of liabilities
are as under:
1. Current liabilities: It is debt that must be paid in the short term or in very near future.
E.g. crop loans, account payable, hand loan, cost of maintenance of cattle, etc.
2. Intermediate liabilities: These loans are due for the repayment within a period of
two to five years. E.g. livestock loans, machinery loans, etc.
3. Long term liabilities: The duration of loan payments more than five years. E.g.
tractor loans.
Net Worth (Equity): If total assets > total liabilities it is called net worth or equity
(Total assets - Total liabilities) and its converse is known as net deficit.
Liquidity: It is the capacity of the farmer to meet immediate financial obligations.
Solvency: It is the financial ability to pay debts when they become due. It represents the
 possession of surplus assets over the liabilities.

EXAMPLE

Following is the details of Assets and Liabilities of a hypothetical Farm as on

31-1-2011. Do the following exercise.
1) Prepare Balance Sheet.
2) Calculate different test ratio to know the financial position/stability of farm business
and also give your interpretation in relation to test ratio.

Sr.No. Item Amount (Rs.)

Assets
1 Value of land (including bore-well and orchard) 10,00,000
2 Tractor 2,00,000
3 Machinery and Implements 1,00,000
4 Bullocks 30,000
5 Dairy cattle 50,000
6 Farm buildings 50,000
7 Cash on hand 10,000
8 Saving in bank 25,000
9 Value of farm produce ready for disposable 1,00,000
10 Value of livestock products ready for sale 10,000
11 Fruits/vegetable ready for sale 10,000
12 Value of bonds/shares to be realized in the current year 50,000
Liabilities
1 Tractor Loan (outstanding amount) 1,20,000
2 Machinery Loan (outstanding amount) 50,000
3 Orchard Loan (outstanding amount) 75,000
4 Crop loans to be repaid to bank 40,000
5 Unsecured loan for bore-well (to be paid within 3 years) 50,000
6 Live stock loan (outstanding amount) 30,000
7 Hand loans 10,000
8 Account payable 10,000
9 Money owned to input suppliers 25,000
10 Annual installment of MT & LT loans 25,000
 SOLUTION

(1) Balance Sheet:

Balance Sheet of a Hypothetical Farm As on 31-1-2011
Assets Amount Liabilities Amount
(A) Current Assets: (A) Current Liabilities:
Cash on hand 10,000 Crop loans to be repaid to bank 40,000
Saving in bank 25,000 Hand loans 10,000
Value of farm produce
100,000 Account payable 10,000
ready for disposable
Value of livestock products Money owned to input
10,000 25,000
ready for sale suppliers
Fruits/vegetable ready Annual installment of
10,000 25,000
for sale MT & LT loans
Value of bonds/ shares to be
50,000
realized in the current year
Sub-Total 2,05,000 Sub-Total 1,10,000
(B) Intermediate Assets: (B) Intermediate Liabilities:
Machinery Loan
Tractor 2,00,000 50,000
(outstanding amount)
Live stock loan
Machinery and Implements 1,00,000 30,000
(outstanding amount)
Unsecured loan for bore-well
Bullocks 30,000 50,000
(to be paid within 3 years)
Dairy cattle 50,000
Sub-Total 3,80,000 Sub-Total 1,30,000

(C) Long term Assets: (C) Long term Liabilities:

Value of land (including Tractor Loan
10,00,000 1,20,000
bore-well and orchard) (outstanding amount)
Orchard Loan
Farm buildings 50,000 75,000
(outstanding amount)
Sub-Total 10,50,000 Sub-Total 1,95,000
Total Assets 16,35,000 Total Liabilities 4,35,000
Net Worth or Equity 12,00,000
 Total Liabilities + Net Worth 16,35,000

(2) Test Ratio and their interpretation:

The balance sheet is analyzed with the help of ratio measures, so as to know the
financial position and stability of the farm business. They are as under:
1. Current Ratio
2. Intermediate Ratio or Working Ratio
3. Net Capital Ratio
4. Current Liability
5. Debt Equity Ratio
6. Equity Value Ratio

1. Current Ratio
Total Current Assets 2,05,000
Current Ratio = ------------------------------ = ----------- = 1.86
Total Current Liabilities 1,10,000
This ratio indicates the capacity of the farmer to meet immediate financial obligations
(liquidity). It reflects liquidity within one year's time. A ratio of more than one indicates a
favourable run of the farm business. If current assets are more than current liabilities and
even though the farmer fails to repay the loan (in spite of his position being solvent), it is a
case of willful-defaulter.
2. Intermediate Ratio (Working Ratio)
Total Curr. Assets + Total Int. Assets
Intermediate (Working) Ratio = ------------------------------------------------
Total Curr. Lia. + Total Int. Lia.

2,05,000 + 3,80,000 5,85,000

= ---------------------------- = ------------- = 2.44
1,10,000 + 1,30,000 2,40,000
This ratio indicates the liquidity position of the farm business over an intermediate
period of time, ranging from 2 to 5 years. A ratio of more than one indicates sound running
of the farm business.
3. Net Capital Ratio
Total Assets 16,35,000
Net Capital Ratio = --------------------- = ------------ = 3.76
Total Liabilities 4,35,000
This ratio indicates the long-term liquidity position of the farmers. If the net capital
ratio is more than one, the funds of institutional agencies are safe. A consistently increasing
ratio over the years reveals the sound financial growth of farm business. The farmer with this
record should be a very prompt repayer of all types of credit obligations. This ratio is also
most important measure of overall solvency position of the farmer as a borrower.

4. Current Liability
Current Liabilities 1,10,000
 Current Liability = ----------------------- = ------------- = 0.09
Owner’s Equity 12,00,000
This ratio indicates the farmer's immediate financial obligations against the net worth.
A ratio is less than one indicates a healthy performance of the farm business and over the
years the ratio should become smaller and smaller to reflect a consistently good performance.
5. Debt Equity Ratio (Leverage Ratio)
Total Debts (Liabilities) 4,35,000
Debt Equity Ratio = ----------------------------- = ------------- = 0.36
Owner’s Equity 12,00,000
This ratio represents the capacity of the farmer to meet the long term commitments. A
consistently falling ratio indicates a very healthy performance of farming and the ability of
the farmer to reduce dependence on borrowings.
6. Equity Value Ratio
Owner’s Equity 12,00,000
Equity value Ratio = ------------------------ = ---------------- = 0.73
Total Assets 16,35,000
This ratio highlights the productivity gained by the farmer in relation to the assets
he has. The improvement in the ratio over the years makes it clear regarding the increased
strength in the financial structure of the farm business.

SUMMARY
RATIO Indicator Interpretation
Current Ratio Immediate liquidity > 1 indicates a favourable run of the
(within one year) farm business.
Intermediate Ratio Intermediate liquidity > 1 indicates sound running of the farm
or Working Ratio ( 2 to 5 years). business.
Net Capital Ratio Long-term liquidity > 1 indicates the funds of institutional
(more than 5 years) and agencies are safe. A consistently
overall solvency increasing ratio over the years reveals the
position.
sound financial growth of farm business.
Current Liability Immediate financial < 1 indicates healthy performance of
obligations against the the farm business. The decrease in the
net worth. ratio over the years reflects a consistently
good performance.
Debt Equity Ratio Capacity to meet the long < 1 indicates healthy performance of
or Leverage Ratio term commitments. the farm business. The decrease in the
ratio over the years reflects a consistently
good performance.
Equity Value Ratio Productivity gained in It is generally < 1. The increase in the
relation to the assets. ratio over the years indicates the increased
financial strength of the farm business.