Basic economicsE-learning course from ESA

Daan WESTRIK

ZBO101R11560

Table of contentsI - Basic economics 3

1. Objectives ..................................................................................................................................... 3

2. Balance sheet ............................................................................................................................... 3

2.1. Assets .................................................................................................................................................................... 42.2. Fixed assets .......................................................................................................................................................... 42.3. Current assets ....................................................................................................................................................... 42.4. Own equity ............................................................................................................................................................ 42.5. Liabilities ............................................................................................................................................................... 42.6. Solvency ................................................................................................................................................................ 5

3. Profit and loss account ............................................................................................................... 5

3.1. Revenues ............................................................................................................................................................... 63.2. Costs ...................................................................................................................................................................... 63.3. Gross margin ........................................................................................................................................................ 63.4. Depreciation and amortization ............................................................................................................................ 73.5. Profit ...................................................................................................................................................................... 73.6. Savings .................................................................................................................................................................. 73.7. Reserve capacity .................................................................................................................................................. 73.8. Liquidity ................................................................................................................................................................. 73.9. Gross cash flow .................................................................................................................................................... 73.10. Net cash flow ....................................................................................................................................................... 7

4. Exercises ...................................................................................................................................... 8

4.1. Exercice : Samuel's farm ..................................................................................................................................... 84.2. Exercice : John's farm .......................................................................................................................................... 94.3. Exercice : Peter's farm ....................................................................................................................................... 10

5. Advised reading ......................................................................................................................... 11

Exercises solution 12

Basic economics

3

The aim of the ladmec programme is to prepare students to be able to guide and advice dairy farmers in emerging countries. To be able to support a sustainable development of dairy farms in emerging countries farm consultants need proper knowledge of business planning and financial management on strategic and tactical level. This online module gives students the possibility to acquire knowledge about the main aspects of financial management. Knowledge necessary to be able to develop and evaluate strategic plans and be prepared to participate in the ladmec program. In this online module the main aspects of a balance sheet and profit- and loss account are explained. Also the main financial keywords are explained. This online module contains also some exercises to offer students the possibility to practise with working with a balance sheet and profit- and loss account. Possibilities for further reading are indicated.

1. Objectives

The student is able to:

explain the different components of a balance sheet;explain the difference between fixed and current assets;explain the difference between long term and short term liabilities;calculate the value of one component of a balance sheet in case information about other components of a balance sheet is given;calculate the solvency using information from a balance sheet;able to interpret a given or calculated solvency;explain the most important components of a profit and loss account of a dairy farm;explain the difference between variable and fixed costs;calculate the gross margin;interpret a given or calculated gross margin;explain the difference between costs and expenses (or cash outflow);explain (and calculate) depreciation;calculate changes in the balance sheet and profit and loss account based on given or calculated costs and expenses;calculate the profit based on information provided in a profit and loss account;explain a given or calculated savings, reserve capacity and liquidity.

2. Balance sheet

A balance sheet is a ‘snapshot' of the value of the total value of a company on an given moment (usually presented on the left side) and on the right sight how this is financed. Both sides must be in ‘balance'.

These items are presented is in a regular order, whereby the order of liquidity of the items the way is to order the items on the balance. The format used in most Anglican countries is to put the most liquid item (cash) on top. In most European (related) countries it is the other way around.

Complement

Reading Tip: http://en.wikipedia.org/wiki/Balance_sheet

Basic economicsI

4

Below you will find an example of a balance sheet of a dairy farm.

Example of a balance sheet

2.1. AssetsTo produce goods and/or services an enterprise requires resources. These resources owned by the company are called assets. The value representing these assets can be found on a balance sheet. Examples of assets in a dairy farm are land, machinery and cattle. But also roughage in stock, debtors and cash. The value representing the assets is equal to the value representing the liabilities.

2.2. Fixed assetsThe part of the assets with a lifetime longer than a year are called fixed assets. Within the fixed assets intangible and tangible assets are distinguished. Examples of fixed assets are production rights, buildings, machinery and cattle.

2.2.1. Intangible assets

Intangible assets are those fixed assets which doesn't have a physical appearance and are sometimes difficult to value. Examples of these intangible assets are production rights or paid goodwill.

2.2.2. Tangible assets

The tangible assets are those fixed assets which have a physical appearance.

2.3. Current assetsThe part of the assets with a lifetime shorter than a year are called current assets. Examples of these current assets are feed in stock, money to be received from debtors and money in cash.

2.4. Own equityOwn equity expresses the difference between assets and liabilities. In case of the liquidation of a enterprise. This is the amount of money with remains when all assets are sold and financial obligations are reimbursed. In other words, own equity is the capital in the firm which belongs to the entrepreneur or shareholders.

2.5. LiabilitiesAn enterprise needs money to finance the assets. In a balance sheet this can be found under the liabilities. Within liabilities the Own Equity, Long term Liabilities and Short term liabilities can be determined. The value representing the liabilities is equal to the value representing the assets.

5

1.

2.

2.5.1. Long term liabilities

Long term liabilities represent the long term financial obligations to finance the (fixed)assets. For example: loans from a bank or family members.

2.5.2. Short term liabilities

Short term liabilities represent the short term financial obligations to finance the (current)assets. For example a bank overdraft or the money still to be payed to creditors.

2.6. SolvencySolvency is a rate which expresses how much % of a businesses is really yours. To calculate this number you divide the own equity with the total of the balance sheet. In the example the solvency is 65%.

Method

Google for two or three annual reports of a well-known company and look if you understand the presented balance sheet (make a print of the pages with the balance sheets).Make your own personal balance sheet in excel and calculate your own equity.

Take these exercises with you for the first lesson.

3. Profit and loss account

The profit and loss account consist of an overview of revenues and costs. This is the basis for the calculation of the profit and cash flow.

6

Example of a profit and loss account of a dairy farm

3.1. RevenuesA profit and loss account usually starts with a statement of the different revenues (or sales or turnover).

3.2. CostsCosts can be calculated costs only or consist of real expenses (cash outflows). Depreciation is an example of an calculated cost without a cash outflow. Feeding costs and veterinary costs are examples of costs which are real expenses which result in a cash outflow.

3.2.1. Variable costs

Variable costs (also called allocated costs or expenses) are costs which are dependent of the production. When the production increases or decreases the variable costs will change as well. In case the production is stopped the costs will stop as well.

3.2.2. Fixed costs

Fixed costs (also called non-allocated costs) are those costs which are independent of the production of the enterprise. In case the production increases or decreases the fixed costs remain the same. In case the production is stopped theses costs will not stop automatically.

3.3. Gross marginRevenues minus variable costs result in a gross margin. In case the gross margin includes only milk production it's expressed as gross margin milk. In case it includes also other production activities it's expressed as gross margin farm.

7

3.4. Depreciation and amortizationDepreciation and amortization represent the decrease in value of the fixed asset. Depreciation and amortization are costs but don't result in a cash outflow. Amortization is a term used for intangible fixed assets. Depreciation is a term used for tangible fixed assets.

3.5. ProfitGross margin farm minus fixed costs, paid interest and amortization and/or depreciation result in profit (EBT...). Based on the profit the amount of tax to be paid to the government (Dutch situation) is calculated.

3.6. SavingsProfit minus tax paid results in savings.

3.7. Reserve capacityReserve capacity is the amount of money available to repay loans or to do (replacement) investments. It's calculated by net cash flow minus tax. This is a specific value only used by specific organisations.

3.8. LiquidityLiquidity is the amount of money remaining from the reserve capacity after repayments and (replacement) investments are done. It's calculated by reserve capacity minus investments paid with available cash and repayments.

3.9. Gross cash flowThe gross margin minus the fixed costs result in a gross cash flow (EBITDA...).

3.10. Net cash flowThe gross cash flow minus the interest paid for liabilities result in the net cash flow (EBTDA...).

Exercice : Samuel's farm

8

4. Exercises

4.1. Exercice : Samuel's farmSamuel runs an arable farm in the area of mount Kenya. The simplified balance sheet is stated below:

The solvency of Samuel's company is 50%.

Fill the 3 missing values.

Balance sheet

Fixed Assets Equity

Land $ 330.000 Samuel $           

Buildings $           

Farm machinery $ 95.000 Liabilities

Mortgage (15 yr) $           

Current Assets Accounts payable $ 100.000

Bank account $ 15.000

Total $ 600.000 Total $ 600.000

[ ]solution n°1 *[ ] p.12

Exercice

9

4.2. Exercice : John's farm

4.2.1. Exercice

4.2.2. Exercice

[ ]solution n°2 *[ ] p.12

John has a dairy farm with 50 cows and an annual production of 250.000 kg milk. His income sheet (simplified) is stated below:

John decides to enlarge his farm. He needs another building for his animals. Which costs will increase due to the investment in the building?

fixed costs

variable costs

Which of the following purchases leads to change in variable costs?

Building

Machinery

Cows

Concentrate

Hay

Exercice

10

4.3. Exercice : Peter's farmOn the first of January Peter starts a beef farm. He has savings of $ 50.000 which he puts on the farm bank account and he can get a loan from his aunt in Marocco of $ 100.000 at 5% interest and pay off in 10 years. He uses this money, together with his bank account to make his investments.

Land $ 50.000

Buildings (estimated life span 10 years) $ 30.000

Farm equipment (estimated life span 5 years) $ 30.000

TOTAL $ 110.000

In March he sows maize.

At the end of the year (31 of December) Peter looks back and makes up the balances and evaluates the year. Interest and payment of the loan of his aunt are not done yet. This will be done in June coming year. Peter's costs of living were $ 5.000 and were withdrawn from the farm bank account.

Maize seed $ 300

Expenses for crop protection $ 600

Other costs (maintenance etc.) $ 1.000

TOTAL $ 1.900

After harvest Peter sells 50% of his harvest. The remaining part he keeps in stock.

For the maize sold he receives $ 10.000.

After harvest Peter sells 50% of his harvest. The remaining part he keeps in stock.

For the maize sold he receives $ 10.000.

4.3.1. Exercice

4.3.2. Exercice

4.3.3. Exercice

4.3.4. Exercice

[ ]solution n°3 *[ ] p.13

What is the total of the revenues in Peter's first year? (write only the total and not « $ »).

          

What is the total of the variable costs in Peter's first year? (write only the total and not « $ »).

          

What is the total of the fixed costs in Peter's first year? (write only the total and not « $ »).

          

What is the balance of Peter's bank account at the end of the year? (write only the total and not « $ »).

          

Advised reading

11

5. Advised reading

M.P. BROUWERS and W. KOETZIER; "The basics of financial management Noordhoff", Third edition, 2015.N. ACHTEN and J. HULSEN; "Economics & Milking", Roodbont Publicers B.V., Zutphen, 2016.

Exercises solution

12

Exercice p. 9> Solution n°2

Exercice p. 8> Solution n°1

Samuel runs an arable farm in the area of mount Kenya. The simplified balance sheet is stated below:

The solvency of Samuel's company is 50%.

Fill the 3 missing values.

Balance sheet

Fixed Assets Equity

Land $ 330.000 Samuel $ 300.000

Buildings $ 160.000

Farm machinery $ 95.000 Liabilities

Mortgage (15 yr) $ 200.000

Current Assets Accounts payable $ 100.000

Bank account $ 15.000

Total $ 600.000 Total $ 600.000

Exercice

John has a dairy farm with 50 cows and an annual production of 250.000 kg milk. His income sheet (simplified) is stated below:

John decides to enlarge his farm. He needs another building for his animals. Which costs will increase due to the investment in the building?

fixed costs

Exercises solution

Exercises solution

13

Exercice p. 10> Solution n°3

variable costs

Exercice

Which of the following purchases leads to change in variable costs?

Building

Machinery

Cows

Concentrate

Hay

Exercice

What is the total of the revenues in Peter's first year? (write only the total and not « $ »).

20.000Exercice

What is the total of the variable costs in Peter's first year? (write only the total and not « $ »).

1.900Exercice

What is the total of the fixed costs in Peter's first year? (write only the total and not « $ »).

14.000Exercice

What is the balance of Peter's bank account at the end of the year? (write only the total and not « $ »).

43.100