Farm Management

1. Farm Management Chapter 11 Partial Budgeting

2. The Use of Partial Budgeting in Enterprise and Farm Planning Partial budgeting • Assess the effect of changes on the overall profitability • Effect in choosing between technology and enterprise. • looks at only gross income and expense items that are affected by the proposed change. • It looks at the economic and non-economic pros and cons of a proposed change. • Decisions on a small farm involve only some of the farm enterprises. • The decisions taken often affect the income and costs of the farm enterprises.

3. When is it useful? • Farmers can employ the resources available in more than a single way in response to changes in product prices, market demand and the cropping pattern. • Partial budgets are useful to evaluate changes such as: " expanding an enterprise, " selecting alternative enterprises, " selecting different production practices, " deciding whether to purchase equipment or hire " making a capital improvement " buying new equipment to replace hand labor or maintaining an older equipment

4. Partial budgeting is based on the principle that a small change in the organization of a farm will have one or more of the following effects: • Eliminate or reduce some costs. • Eliminate or reduce some gross incomes. • Cause additional costs to be incurred. • Cause additional gross incomes to be received

5. Uses of a Partial Budget • Often the best way to analyze a change • in operations involving several different • enterprises. • Provides a formal and consistent method for • calculating the expected change in profit • from a proposed change in the farm business. • It is a form of marginal analysis.

6. Steps in Preparing a Partial Budget • Example: A farmer is considering irrigating his 0.5 acre ginger enterprise. The present situation “without irrigation” is as follows. How should the farmer proceed?

8. Steps in Preparing a Partial Budget • Step 1 - State the Proposed Change Introduction of irrigation to 0.5 acres of ginger • Step 2 - List the Added Annual Returns # Additional gross income. In this case, the irrigation will increase production by 300 kg of ginger or $1,350 (300 kg @ $4.50) annually. • Step 3 - List the Reduced Annual Costs # No reduction in annual costs. • Step 4 - List Added Annual Costs The additional annual costs is the extra labor for preparing water channels, water application and for extra harvest, extra cost for transportation and marketing.

9. Step 5 - List the Reduced Annual Gross Incomes # No reduction in annual gross incomes • Step 6 - Estimate Changes in Annual Farm Income # In this example, the farm income would increase by $1,035 due to the introduction of irrigation • Step 7 – Non-economic Considerations # non-economic factors: any social aspects of having more/less family members working on the farm, increased flexibility in the production cycle, etc.

11. Figure 11-1Partial budgeting and marginal analysis

12. Partial Budgeting Procedure • What new or additional costs will be incurred? • What current costs will be reduced or eliminated? • What new or additional revenue will be received? • What current revenue will be lost or reduced?

13. The Partial Budget Format • Additional Costs: costs that do not exist at current time but will be incurred if the change is made • Reduced Revenue: revenue that is currently received but which will be lost or reduced if the change is made • Additional Revenue: revenue to be received only if the alternative is adopted • Reduced Costs: costs that are now incurred which would be eliminated if the change is made

14. Table 11-1Partial Budget Form

15. Added Costs Reduced Returns Sub Total Added Returns Reduced Costs Sub Total Change in Net Income Problem #1

16. Problem # 1 • Use the following information to complete a partial budget.

17. Problem #1 I. A.M. Farmer, needs to know if it would be economically advantageous to have his 1,000 acres of wheat custom sprayed.

18. Problem #1 • Custom Spray Rate = $4 per acre • Additional Labor Costs for John to show where to spray = $ .15 per acre • Increase in yield due to spraying is 2 bu. Per acre.

19. Problem # 1 • Wheat is expected to be $3.60 per bu. • John’s Sprayer Wheels will cause 1/2 bu/acre loss of crop.

20. Problem #1 Should John Custom Spray?

21. Added Costs 1,000 x 4 = 4,000 1,000 x .15 = 150 Problem #1

22. Problem #1 Added Costs 1,000 x 4 = 4,000 1,000 x .15 = 150 Reduced Returns .5 x 3.60 = 1,800 Sub Total 5,950

23. Problem #1 Added Returns 2 x 3.60 x 1,000 = 7,200 Reduced Costs Sub Total 7,200

24. Problem #1 Added Returns 2 x 3.60 x 1,000 = 7,200 Reduced Costs Sub Total 7,200 Change in Net Income +1250 Added Costs 1,000 x 4 = 4,000 1,000 x .15 = 150 Reduced Returns .5 x 3.60 = 1,800 Sub Total 5,950

25. Partial Budgeting Examples Table 11-2 is a fairly simple budget analyzing the profitability of purchasing a combine to replace the current practice of hiring a custom combine operator to harvest 1,000 acres of wheat. Table 11-3 looks at a proposed change of adding 50 beef cows to an existing herd. To accommodate the additional cows, 100 acres currently in grain production would need to be converted to forage production.

26. Table 11-2Partial Budget for Owning Combine Versus Custom Hiring

27. Table 11-3Partial Budget for Adding 50 Beef Cows

28. Factors to Consider when Computing Changes in Revenue and Costs Costs may not change proportionately when you are changing the size of an existing enterprise. Fixed costs, in particular, may not change much, if any, if the change in size of the enterprise is relatively small. It is also important to be careful not to overlook changes in opportunity costs. Finally, the unit of change used in a partial budget should be consistent throughout. Some alternatives can be analyzed on a per acre basis, but others can only be analyzed for the entire farm.

29. Sensitivity Analysis Sensitivity analysis involves computing the partial budget several different times, using different price and yield figures each time. One way to do this is to use low, average, and high values for prices and yields. Another way is to look at prices or yields which are 10, 20, and 30 percent higher and lower than expected.

30. Limitations of Partial Budgets Partial budgets are easy to use and require minimal data. However, partial budgeting can only compare the present management plan with one alternative at a time. If there are many alternatives to consider, the manager will need to develop many partial budgets. Also, partial budgeting uses one set of price and yield expectations. If these are variable, cash flow may be a problem in some years.

31. Final Considerations Before adopting a proposed change that appears profitable, additional risk and capital requirements should be considered.

32. Summary A partial budget is an extremely useful type of budget. Partial budgets analyze the profitability of a proposed change in the operation. Data requirements are small. The sum of additional costs and reduced revenue is subtracted from the sum of additional revenue and reduced costs to find the expected change in profit from making the change.