I.
Balance Sheets
Exercise #1. This farm has a short-term liquidity problems as evidenced by a current ratio of
0.88 and negative working capital (-$22,367). The overall debt load is greater than the net
worth, as seen by the debt/equity ratio of 1.1. Approximately one-third of the debt is in current
liabilities. The major problem in this balance sheet is that there is a large equipment loan
payment due that particular year. Further analysis should examine alternatives to reduce that
payment. These could include restructuring the equipment loan to spread smaller payments over
more years, sale of equipment that is rarely used to assist with the payment (would need to sell at
least $23,000 worth of equipment). This is only advisable if these are equipment items that are
rarely used. Leased equipment can sometimes be substituted for owning equipment, but careful
analysis of the effect on profitability is needed before choosing that option.
Exercise #2. This farm currently is insolvent as evidenced by a negative net worth (-$12,733).
The debt/asset ratio also shows that debt obligations are slightly greater than the value of the
assets in the business. Indicators that include equity are all negative, given the negative net
worth. The current ratio shows that there are just enough current assets to cover current
liabilities with a very small cushion of working capital of $265. However, the debt structure
shows that, overall, most of the debt is long term. While negative net worth is not desirable, it is
also fairly common for new, startup farms. While insolvent, if this is a new farm with a positive
pro forma income statement for the coming year, this farm likely will see its financial position
improve as long-term debts are paid down and the farm moves into full production. Of greater
concern is the very small cushion of working capital. This is a preliminary indicator of risk of
not having sufficient liquidity. The farm should prepare a detailed cash flow budget for the
upcoming year to be certain that there will be adequate cash flow. Acquiring additional
operating capital should be considered to get through the year, as long as the cash flow budget
shows that that option is feasible.
Exercise #3. This farm demonstrates declining net worth over time. This likely is an older farm
on which depreciation is dropping the value of the equipment more rapidly than the loan
payments are decreasing liabilities. Financial ratios are within acceptable ranges; so, there is no
immediate problem. However, businesses ideally demonstrate increasing net worth over time. It
would be prudent for the manager of this farm to develop an equipment replacement schedule
and evaluate the most appropriate time to replace this older equipment.