FARM MANAGEMENT PROCESSES, MONITORING PERFORMANCE AND
Howard Doster, 8/2/08, Copyright 2008
Forward is where we’ll be in the next time instant. Past physical performance is the best indicator of future physical performance; that’s why we study past cropping system field trials and livestock feed trials. But, I now realize, past prices and costs don’t count as we decide what to do, from now on.
Value, Value, Value,
Cost, Cost, Cost,
Who Is Lost?
That’s the poem I wrote my accounting professor on my PhD
prelims in Agricultural Economics. I’ve
asked myself that question many times as I’ve served as a Land Grant “change
agent” most of the last 55 years, starting as a 20-year-old summer county agent
two days after losing two finger tips in a hay mowing accident; then as an
Extension radio farm news broadcaster; an OSU Instructor for six years as I
helped research cost of raising hogs, beef, dairy, & crops &
coordinated the Ohio farm records program, before finishing a PhD & moving
to Purdue. There, I also coordinated the
I first wrote this “Management Processes” text to help students, young & old, create their business plans. I was never satisfied with the business plan budgets in others’ books. Several times along the way, I worked on earlier versions of the budget I am about to teach you. Together with your help, perhaps we’ll get it right this time.
How will you decide and act, from now on? This is our job as owner-manager of our resources. How many alternatives do you test before you decide and act? Life-cycle budget (LCB) is the name I’ve given software I’ve been working on since I started my MS thesis on “Expectations” over 50 years ago. Later, as a young professor, I helped two graduate students try to program budgeting software with variance analysis. They graduated; but I didn’t get the software finished.
I now identify the fatal flaw in both my MS and my variance analysis budget. It is this. You and I decide and act as soon as we recognize that observed performance is different from expected performance, not weeks or months later. With LCB, you can test alternative solutions right after you identify a problem/opportunity and determine the cause/reason. Once you learn to use LCB, expect to test multiple contingency IF/THEN plans even before you need to use them.
Never much of a programmer myself, my wife, Barbara, and I, both retired Purdue management teachers, and now management coaches, have as our motto:
We do what we do best
-our comparative advantage-
and trade for the rest.
How about you?
Norm Brown of FBS is now programming LCB. Perhaps with your help, we’ll get it useful enough so that someone will teach more persons to use it than the 7,000 mostly corn belt farmers my public and private colleagues and I have taught to use another budget I co-authored, the Purdue Linear Program Crop Budget (PCLP). We’ve helped those farmers interpret 25,000 solutions as they’ve tested alternative crop rotations, machinery sizes, tillage systems, and/or farm sizes.
Test before you invest.
Test cropping system timeliness alternatives in PCLP.
Test physical/financial alternatives, from now on, in LCB.
Now, let me share how Norm and I learned to respect each other. Three-plus years ago, I read where Norm, whom I then didn’t know, was presenting his new so-called managerial accounting software, based on Farm Financial Standards Council (FFSC) rules, at a Louisville workshop, just ahead of the Machinery Show. This software sounded great, and I emailed Norm to learn if Barbara and I could attend. Maybe we could use Norm’s software. Anyway, he invited us to participate, provided I gave my seven-minute “Test before you invest” speech. That was an easy trade. I’ve given that machinery economics speech, from three minutes to three days, 900 times in 12 countries on five continents.
After learning all day about Norm’s new software, I gave my speech. Soon, a former student asked what I thought of Norm’s managerial accounting program. I gulped. I was his guest! What could I say? I just said, “It’s the best activity-based cost accounting system I’ve seen…and I have no use for it.” Wow, Norm coughed, and the meeting ended. But, thanks to Norm, our association was just beginning.
Three weeks later, Norm and his wife, Cheryl, spent the
night with us at our
I looked at Norm. The farmer was his client, but Norm was silent. So I asked, “When did you finish harvest last fall?” The farmer answered, “After Thanksgiving, as usual.” As I reached for my phone, I asked, “Earlier today, did I hear you say you had hit a home run last summer-you grew a big crop and you sold it right? “That’s correct,” he said. “What’s your address?” I asked. “I want to send you an input form for the Purdue Linear Program crop budget. Use it to test for timeliness, not your past financial history.” That day, Norm and his farmer never did use his historical accounting reports for anything, except to get them correct.
Help us make LCB effective, do right things;
efficient, do things right;
& enjoyable to use, from now on.
After learning ourselves & teaching you to use LCB, then what? I think LCB should be taught in freshman farm management classes; then also used in other management, marketing and finance classes through the MS degree, including in virtual classes to anyone, anywhere. Professors using LCB might help Purdue become The Farm Management Center for Eastern Corn Belt Land Grants. Students, teachers, and consultants could learn, teach and coach so much more effectively, efficiently, and enjoyably than at present.
Oh, I named “site-specific farming” in a 1983 Purdue publication. Maybe Norm will help tie precision ag and LCB together. I wonder when two former students will link LCB with other software. Ted Macy, president of Map-shots, does a lot of precision ag software for large farm machinery firms, and is a proponent of open architecture software. He married my secretary, and, with our two sons, started Farm Computers, Inc while in college. Keith Schuman, co-founder while in college, and now president of S&S Programming, has two packages that could be integrated into LCB; his Herdsman swine genetics program that’s becoming the world standard, and his useful commodity charting software.
In March 1973, then Department Head Charles French, in one breath, told me: I had been promoted to associate professor; I would never be professor; but I could stay at Purdue, run the Top Farmer Workshop, and work on management information systems. Although he was fired shortly thereafter, I did what he said. Now, I’m about ready to change the name of this text to “Farm Management Information Systems (FMIS).” Barbara and I look forward to learning and teaching others how to use LCB as we help you improve your FMIS. What fun.
We start every day
Where we now are
With what we now have
And what we now want most
Our Management Job
No one wants to waste resources. Yet, with about the same resources, some persons realize more rewards. We say those persons are better managers. They do right things. They do things right. They are effective and efficient, and they likely enjoy what they are doing.
Management might be defined as:
The problem solving process of deciding what to do and doing it,
as we use what we now have
to get what we now want most.
As owner-managers of our resources, we use our entrepreneurial skills to decide what to do; then we use our monitoring skills to measure how we’re doing. Thus, management processes include deciding and doing. Steps include monitoring, planning, organizing, staffing, and directing. We learn and use these processes as we decide each day how to use our material resources and our mind/muscle and relationship skills, and as we carry out our decisions.
MONITOR: Observed versus expected performance.
UNDERSTAND: What’s happening and why.
PREDICT: Test alternative solutions and their consequences.
CHANGE: Decide and Act.
MONITOR: for the next surprise.
Trained as an economist, I observe when persons trade with each other, and predict when they will trade.
We trade the use of our resources
When, we think, we will be better off.
If we think we won’t, we don’t.
Read on if you agree so far.
The Management Process
We identify problems/opportunities by monitoring continually what’s happening outside and inside our farm gate. We monitor these actual performances and compare them with our expected performances. Whenever observed is different from expected, we begin to solve a new problem/take advantage of a new opportunity. Once we determine the cause/reason, we consider alternative solutions.
We revise our personal and business plans, our expected performances, repeatedly. These plans include our strategic vision, mission, objectives and goals; and our tactics or operating plans.
Everyone has stated or unstated plans for the economic functions of his/her business. These functions include financing, personnel, marketing, and production.
The doing part of problem solving includes action by oneself and perhaps others in carrying out the plans by getting organized, staffed, and directed; doing the jobs; and monitoring performance as we continue to look for a new problem/opportunity.
You may identify problems/opportunities anywhere in your business or personal life plan. Right now, make a list of problems/opportunities that come into your mind. For example, in objectives and goals, you may want to: get out the older generation and get in the younger and/or a neighbor; expand/reduce land and/or livestock. In finance, you may want to compare own versus lease land or machinery.
But, use PCLP to test for timeliness. Enter field working rates and machine annualized net present replacement costs for each machine in each solution you test. Continue testing until you find your most “timely” set of machinery, including for different tillage systems, crop rotations, and/or farm sizes.
Use LCB to learn if you can afford to trade for the better size or system now. The problem of choosing an interest or discount rate to use to calculate net present replacement costs is one reason I’m creating LCB. Why? When you test “all” alternatives, including putting surplus funds into CD’s, renting more land, or whatever, you don’t need to estimate a discount rate in LCB, a total budget for using your resources. In a so-called capital budget, which is really a partial budget, your conclusion will be quite dependent on the discount rate you use. Although you probably won’t continue testing alternatives until you realize equal marginal returns to all recipes you use, you could find such a plan using LCB. MS students, is my reasoning right? Is it important to farmers who often trade just a combine or tractor, but not their entire machinery set, unlike when some major companies replace whole factories?
In personnel, you may want to use LCB to compare hire versus partner. In marketing, you may want to compare alternative ways to buy inputs and sell outputs. In production, you have many crop and livestock production functions and cropping/livestock systems to compare, including the consequences of disease, hail, flood, drought, soybean rust, or prospects of a bumper crop on various dates.
When using LCB, you start where you now are, and farm your farm. You compare after tax equity for each alternative, based on expected cash flows, from now on, for the life of assets you are comparing.
For all of the above and many more, you likely want to compare many IF/THEN contingency plans so you are better prepared to act, and not just react, when a surprise occurs. I think being better prepared to act, rather than react, is one of the skills better managers use.
Although this section is titled Identifying problems/opportunities, note that we quickly moved through determining the cause/reason step and considered how to test alternatives. Always take the time and make the effort to determine the cause/reason for each problem/opportunity, and you’ll avoid many unnecessary problems.
Your Pre-Meeting Assignment
For now, just list six problems/opportunities on a sheet of paper, or better yet, in an email to me at Howard@DHDoster.com. I’ll study your list, and be better able to suggest how to use LCB when we meet. For each, write a simple declarative sentence beginning with, “The problem/opportunity is…” and you complete the sentence by identifying the problem/opportunity. Example: The problem is: our business is currently not big enough to include our son.
Now pick one problem/opportunity in your list and go through the four step decision process. Here’s an example.
1. What’s happening-Problem: Our farm is not big enough to include our son.
2. Why-Cause: Our son wants to get married and become a farmer.
3. Alternative solutions and their likely consequences:
a. Perhaps we can expand the business, what are the consequences?
b. One or more of us can work off the farm part or full-time, what are the consequences?
4. Best solution: We decide to do “b”. Our son and his wife can get a town job nearby and help out here nights and weekends.
While we all include emotional as well as business criteria in our decision-making, we can likely improve our decisions if we can compare the financial consequences better than we’re now doing. That’s the reason we’re creating and teaching you to use Life-Cycle Budget. In addition to sharing your six problems/opportunities, please tell us the questions you now have about using LCB.
PERSONAL VERSUS MARKET VALUE AND WHY EACH MATTERS
It’s Worth More
Than I Can Get For It
How many times have you heard someone say, “It’s worth more than I can get for it?” What does that mean? Perhaps you were walking together by an older farm machine or auto or whatever. Perhaps you just nodded and walked on.
Read the statement again. What causes a person to say this or think this way? Think about the consequences of what it means. Each of us keeps each of our material resources, or assets, because we can somehow get more out of it-it is somehow worth more to us-than we can get for it in the market!
I Can Get More Out Of It
Than I can Get For It
The logic and/or emotion in that statement drives our decision-making performance. It’s a reason why we’re different from other creatures. Read on, if you agree. Why? IF/THEN… If this is true, then you will want to learn the logic and use our Life-Cycle Budget (LCB) software, from now on. Hang on. Let’s start to describe our decision-making performance near the beginning, before quickly jumping to today, and, from now on.
You and I are owners of our material resources, and our mind/muscle and relationship skills. We were born with no material resources, and, we’ll take none with us. We did have a potential for acquiring mind/muscle and relationship skills, and we continue to learn and use more of our potential.
How did you get your material resources? We’ve been gifted some, and we’ve traded mind/muscle and relationship skills, and earned material resources. We’ve consumed some resources, gifted away, or traded some, and we’ve retained some. Some of our material resources have changed in value since we acquired them. Finally, we’ve somehow borrowed resources from others with the promise we will pay them back an equal amount plus something for the use of them for a period of time.
You’ll describe how you acquired each of your material resources and your debts when you use LCB.
Trained as an economist,
I observe when persons trade with each other,
and predict when they will trade.
While professional appraisers have a longer definition, market value is one’s estimate of what a typical buyer will pay for an asset today. You appraise the market value of your material resources often.
Appraisers estimate market value.
Accountants record past entity costs.
We compare personal and market value.
Whenever market value is more, we trade.
Our Retain/Replace Decision
Here’s why personal and market value matter. Everything we now have must somehow be worth more to us than if we were to trade it. When, we think, it is worth more to someone else, we trade. We can hire a professional appraiser, who also thinks like an economist, to estimate what a typical buyer will pay. We also do this market value estimate, plus our personal value estimate multiple times daily. By using LCB we learn an effective, efficient, enjoyable, process for testing whether to trade now. That’s our job as owner-managers of our resources.
YOUR BIG INFORMATION TABLE
When Norm finishes, he’ll have a place for you to store your physical/financial assets, your debts, and what’s left, your financial equity. His table is so big, for each alternative plan, LCB will budget your expected transactions, one at a time, and create a new financial balance sheet after each trade-transaction with someone outside your business, and each event within your entity, from now on, until the day after you expect to die. He’ll also have a place to store your crop and livestock recipes, your present production functions and others that you might want to test. He’ll “time stamp” each of the assets in the recipes, day by day, for the life of the, say, corn crop, hog cycle, each machine and building, etc. Thus, as you describe an alternative plan, the LCB software will farm your farm, transaction by transaction, from now on, for the life cycle of an asset, including until the day after you expect to die. If you want to run LCB until you die, LCB is programmed to replace shorter lived assets, according to your default directions. As you can begin to see, this is a big information table, but let’s start where you now are.
Your Mental Assignment
In your mind, make a list, an inventory, of your material resources, describing them in both physical and financial terms. In financial terms, value each of your material resources, also called assets, at your estimate of their current market value. Use a spreadsheet and place your assets, side, by side in one row near the top of the spreadsheet. For each asset, save and later use two columns to describe and account for physical and financial transactions of each, from now on.
Market Value Balance Sheet
Place an “equals” sign at the right end of your row of assets. You are now starting to create your balance sheet, which is your basic accounting equation. It is “assets = debts, sometimes called liabilities + equity, sometimes called net worth. This equation can also be written as “assets – debts = net worth.” Both equations mean the same thing. Professional accountants generally use the first equation.
Though we think like economists, not like accountants, we do use much of the same logic to describe our financial position and performance. We add market value, and calculate other opportunity costs, really, opportunity values. They don’t, yet, although some accounting consultants now do “valuations”.
Now, make a list of your debts or promises. If possible, list your debts in financial amounts, and enter them as column headings to the right of the assets.
The basic accounting equation is “assets= debts + net worth.” Therefore, cause your spreadsheet to add entries in each row of all your asset columns. Also, add entries in each row of your debt columns.
Place a “+” at the right end of your debt row. Thus, for each of your rows down the spreadsheet, the sum of your assets = the sum of your debts + your net worth.
Your Balance Sheet
Your balance sheet is your financial report of the market value of your material assets, less your debts and … In the balance sheet equation, your net worth is whatever is left after your spreadsheet subtracts the total of your debts from the total of your assets. In your mind, you create a new balance sheet multiple times daily, whenever you recognize a change in value. LCB is programmed to create a new balance sheet for each row of your spreadsheet, just after it makes a new entry.
Regardless of your goals, your net worth, like your bank account (one of the asset accounts), must always be positive. Why? Unless he/she offers cash, would you trade with a “bankrupt” person, someone who already owes others more than he/she is worth?
Later, you will learn to create and add several net worth accounts. For now, just remember that you will use one row of your spreadsheet to record a transaction-a trade between you and someone else, and also an event-a change in two or more of your balance sheet accounts that occurs inside your entity. Also remember that the sum of the entries on both sides of the = must be equal. That’s why it’s a balance sheet. Got It?
The balance sheet report is the basic financial accounting report. In your LCB-type spreadsheet, you have a new balance sheet for each row, after each transaction or event is posted. It is a report of an entity-you, me, or a business-as of a date. You and I can estimate our assets and debts, just by making a current list, and thus we can estimate our equity or net worth at any point in time.
After recording the entries for an entity’s first balance sheet, professional accountants collect transactions in temporary income and expense accounts, located in the equity section of their balance sheet, for a period of time, until they prepare another balance sheet, say, at the end of a year. Their new “cost-basis” balance sheet is based on their first balance sheet entries, plus the entries they recorded in their temporary income/expense accounts, and any assets or debts traded.
Because our balance sheet is based on current market value and one made by an accountant is based on historical cost, our estimate may be more useful than balance sheets made by professional accountants. You might ask an accountant, “Other than for IRS and the Securities and Exchange Commission (SEC), who uses your balance sheets, and related period reports, and how and why do they use them?”
If there are no fatal flaws in LCB logic, I predict more owner-managers will ask professional accountants to help them create market value balance sheets and related reports. What do you now think?
Always write the date in the first column of each row of your spreadsheet. Make the second column wide so you can write a description of the transaction you will enter in the columns to the right. Oh, right after the description column, place a column called “Equity”. Have your spreadsheet enter the current equity just after you record the individual amounts in the proper asset, debt, and/or equity accounts. You will have many columns in your spreadsheet. Likely, you want to learn the effect on your equity of any transaction. Therefore, put the current equity where you can easily find it in your spreadsheet. Maybe place a column for your bank account balance next to your equity balance.
Later, you may want to make a line graph of your equity and of your bank balance, transaction by transaction, from now on, until the day after you expect to die. Why? That’s how long you and I are interested in deciding how to use our material resources. Actually, you and I want to learn the likely consequences of retaining each of our assets versus the consequences of trading each now. To test these alternatives, we want to know the affect on our equity as of the end of the time we will use an asset, but I’m jumping too fast.
How do you choose how to use your material resources? As I choose what to do next, I think about the likely consequences on my bank account (cash flow), and my terminal after-tax-equity (TATE) for the life cycle of each alternative I consider in my decision.
Using Production Functions
Before I pick seed, fertilizer, etc, cropping system recipes, I want to know what yields I and others have experienced using various amounts of nitrogen, various seed populations, etc, on my soil types. I use that information to estimate many possible “production functions”, or recipes, for growing crops. Then, I add current prices to those past production performances to calculate the best recipes to use now, where expected marginal cost equals expected marginal revenue. My life cycle for my crop recipe decisions ends after I expect to market the crops, either at an elevator or through my livestock.
Written or unwritten, we all have a benchmark budget (BB) or plan we use as we monitor our performance. I want you to compare TATE for your present BB with TATE for each alternative you consider, before picking the best BB to use, from now on. This means you’ll want to enter your present plan into LCB, from now on, for the life cycle of each recipe, including until the day after you expect to die. Your present plan is your present BB.
Yes, that’s a big assignment. Aren’t you glad Norm is connecting all the dots and making Life Cycle Budget effective, efficient, enjoyable? One fun thing about LCB is that you can start just by entering, say, a cropping system set of recipes, and comparing which is the best among the alternatives you test.
Life Cycle Budgets and Big Information Tables
Think of all the production functions you now use, plus those you might use. Each of those is a recipe for using resources you have or might get. Wow, this is a lot of recipes to put in our big information table (BIT). When programming LCB, Norm is using a data base program, which is similar, but bigger than a spreadsheet, as he makes a place for us to enter our recipes. Oh, he, and you, and I, and others, are entering “default” production functions for many of the kinds of recipes we’ll use. Then, we can merely modify the default numbers to make them represent our plans. Norm is making it easy for us to access our BIT table.
Perhaps you’ll now test before you invest further effort. Try using LCB with default numbers for making some cropping system budgets. I think you’ll agree that using LCB is about the best thing since sliced butter. Norm and I are old 4-H’ers. Our motto still is, “To make the best better.” Help us.
Before I trade combines, I want to know when others have experienced breakdowns-they occur only when I’m using a machine-how much I can harvest with the new machine, for how long, and how much more productive I can be than if I retain my present machine another day. I want similar information about a new swine facility as compared to using my present system another day. Before I get new, higher priced breeding stock, I want to know how much better others have found the stock to be.
Including the above, I have many questions that affect cash flow and taxes. When should I pay for seed? If I’ve decided to sell corn today, what is the best way to price it and when is the best date? Am I better off selling corn before year-end and paying bills, or borrowing money to pay bills now? What about lease versus purchase of a combine? Should I or my son/father buy the next combine? When/how should I begin and continue to put before tax inventories in my son’s profit center? What are the tax consequences of alternative estate plans?
How many times are you surprised each day? You make a decision each time. You have many IF/THEN alternative contingency plans already, including some “knee jerk” responses. Using LCB, you’ll have many more contingency plans, and you’ll test more new plans before you invest.
Of course, I never have all the information I want, but I decide and act, based on the information I have. When I use LCB, I have better information than if I don’t use it. That’s also the reason you will use LCB. Test new alternatives whenever, you think, it’s worth your time to make the test. Using LCB, you’ll likely do more testing than previously. That’s our goal for you. Now, maybe make a list of questions you could better test by using LCB instead of the way you are now making decisions.
For each of my many, many questions, I want to know the effect on my terminal after-tax equity (TATE) and my cash flow I can expect from each alternative way I might use my present resources, and resources I might acquire. Past physical production performance is the single best predictor of future physical production performance. That’s why we look to suppliers, Land Grants, and other farmers for this historical information, and sometimes do our own testing.
You and I, and other owners, managers, appraisers, lenders, and other economists estimate current value, based on expected sales and earnings. Professional lenders and their appraisers estimate current market value.
Monitoring Our Performance
Multiple times daily, you and I monitor our performance by making an inventory of our resources, in both physical and financial terms. When our observed inventory is different from our expected inventory, we identify a problem/opportunity. Then, we determine the cause/reason, consider alternatives, make a new decision, and carry it out. If you agree, read on to learn the consequences of what you’ve just agreed to, and how you can now use new LCB budgeting software to do what you’ve been doing-more effectively, efficiently, and enjoyably,
Professional appraisers estimate market value three ways; by the expected earnings of a typical asset user, by comparable sales, and by replacement cost less functional depreciation. You and I estimate value one more way, for our own use or pleasure. Consider why you have the material assets you now possess. Isn’t it because you have a plan, a recipe, for somehow using each that’s better than any recipe you have for using the replacement you would get in a trade? I’ve come to believe that’s my basic decision criteria.
Professional accountants, including IRS agents, look backward and estimate historical period costs. Except for calculating taxes, past costs and prices don’t count in my decision–making process.
CPA’s use their 130 or so rules to precisely measure past costs, and to summarize transactions in income statement period reports. Their rules call for them to recognize expenses in the period when earnings are realized. This requires accountants to allocate some expenses to different accounting periods, and so-called managerial accountants, formerly called cost accountants, devote considerable effort to estimating total costs. Other than IRS and (SEC), who reads or uses these period reports? True, one can precisely audit transactions from one balance sheet to the next, keeping assets at cost. Why is this useful? Such balance sheets do not reflect current market value, which is the opportunity value-called opportunity cost by economists- that you and I have to sell an asset. Corporate stockholders and potential stockholders look to the appropriate stock market exchange to estimate current market value, not the company’s balance sheet. Lenders look to professional appraisers’ estimates of current market value. You and I also appraise value.
Certainly, records of past physical performance are useful. When used with current prices of replacement assets, useful budget comparisons can be made. That’s what we have programmed our Life-Cycle Budget to do. But, the appropriate period report in LCB is for the time you expect to have the asset, and that’s seldom a calendar year.
Whenever a surprise occurs, you compare your present plan with multiple alternatives, and pick the best budget to use to monitor your performance, from now on, until another surprise occurs.
Personal Value Inferred
We want to find when current market value of our resources is more than current personal value. We retain a resource as long as we have a plan for using it that’s better than any plan we have for using a replacement. We can’t find a present value for an individual asset. We do decide when to trade, however, and when we don’t trade, we can infer that we must have a plan for using a resource that’s better than trading it. Does this make sense? Perhaps Shakespeare wrote “value is in the eye of the beholder.” How else is personal value defined, or used?
Since my first meeting with Norm, he has programmed my thoughts. To test for fatal flaws in my thinking, I have participated in multiple sessions of the Farm Financial Standards Council (FFSC), at considerable personal cost. I continue to be favorably impressed with how precisely, though arbitrarily, the FFSC persons, including academics, CPA’s, consultants, and farmers, allocate overhead. I’ve read glowing magazine articles supposedly showing how farmers used their FFSC accounting. However, I’ve written more in the article margins refuting their claims than the author wrote. At the end of one FFSC session, one person did say, “You need to know your total corn production costs before you can develop your marketing plan.” That’s the most I’ve heard, and, of course, my past costs don’t matter to me or to my buyer.
LCB to BB
Therefore, I want my financial resources to be recorded and kept current in a market value balance sheet, not an accountant’s cost basis balance sheet. Using my appraisal skills, and appropriate LCB software, I will “mark to market” all my assets daily, some, multiple times daily. I will do this whenever I observe that my inventory is different from my expected inventory. Each of us has expectations about our future performances. From now on, perhaps you will write your expected plan for using your resources in a benchmark budget (BB). Then, you will use your BB to monitor your performance until you observe that your actual performance is different.
At that time instant, you have just identified a problem/opportunity. You are no longer on your BB. Move to the second step in problem-solving and determine the cause, not just the symptoms, of the difference.
Now, you are ready for the third step; namely, considering alternative solutions. Perhaps you already have several contingency plans which might work; perhaps you want to test more, to learn likely financial consequences, from now on. Perhaps you are accustomed to testing “partial budgets” with a stubby pencil on an envelope, whatever. Now, you can do better, and do better faster.
If it’s easy and better, why not test alternatives, for the life of an asset, from now on. Recognize the value of doing this for the life of an asset, including your own expected life. No longer will you need to estimate allocations of overhead or depreciation to different crops or livestock activities. And, if you’ve been doing so-called capital budgeting, no longer will you need to estimate an opportunity cost of capital or discount rate.
Perhaps you are now using a spreadsheet to estimate your bank account, your cash flow, for future periods. If that’s your present BB, and you monitor and revise it as needed, you know, and your lender knows, how you are going to maintain a positive balance in your bank account. In our market economy, it’s much easier to specialize in what we do, and trade with others for most of what we want. Others won’t trade if we don’t pay. Your lender insists that you keep a positive bank balance.
But, your lender is mainly concerned about your cash flow, especially your ability to somehow repay your loan. You and most of your significant others have another goal; some want you to maximize financial returns to your resources, subject to your other goals. I do, also.
Maintaining a positive cash flow is necessary for me to trade with others. It’s not sufficient as a goal for me, other than to maintain a positive cash flow while I maximize my other goals, from now on, until the day after I expect to die. How about you?
I make decisions one at a time. Therefore, I want my financial information system to estimate the changes, the consequences, of my decisions, one transaction at a time. Therefore, I want a new balance sheet after each transaction is posted. This is consistent with my ability to reverse or otherwise change my decision in the next time period, or whenever I get new information.
There is a major consequence of marking to market each asset. It is this. Right after you trade for another car or combine, your market value equity will be less than before you traded. Why? Likely, you can’t sell the replacement for what you traded for it, including transaction costs. Then, why will you make the trade? My answer is that your expected equity at the end of your expected use of the machine is more than if you didn’t trade now. Got it? Oh, since you didn’t make a different trade now, it must be more than your equity at the end of the useful life of anything else you might have traded now. Is that true?
Oh, I haven’t directly discussed period income statement reports. Why? Unless others, including IRS, want one, I don’t use annual income statements. Do you? I just look at my expected equity in my balance sheet at the end of the life-cycle of any of my assets, including me.
Because I may mark to market each asset multiple times daily, I recognize the loss in market value of my assets on each balance sheet; thus, I don’t need to allocate future overhead. If I need to have an asset to grow a crop or livestock, I must have it. I can test multiple recipes for using it a little or a lot so as to learn whether to somehow obtain it, or retain it.
While I may, or may not, need to add some type of accounts for assets that are rented, or otherwise contracted, so as to recognize both their future cost and their opportunity cost, I think, and hope, I can eliminate teaching new students how to “minimize losses”. That explanation just seems dumb to me.
Further, if I made a “bad” decision, it was made in a prior point-in-time period. I want to acknowledge it when I recognize it. Then, I always want to test how to use my resources to maximize my rewards, from now on, not just when I want to minimize losses.
The End/The Beginning
Wow, how many fatal flaws have you recognized? This may become significant stuff! I still need to add a chapter on sources and uses of equity, which I think you’ll have fun using. Together, let’s learn to use what Norm has programmed and to help him make our best better!