Partial Budgeting

1. Partial Budgeting AAE 320 Paul D. Mitchell

2. Goal • Explain purpose of partial budgets • Illustrate their structure and use • Give some examples

3. Partial Budget Purpose • Analyze net return from small changes or refinements to farm operation • Partial Budget: focus only on parts that change, not budget each enterprise completely, but build on enterprise budgets • Fine tune current operation: Hold all else fixed to evaluate a small change • Marginal/incremental analysis: change input use, shift between inputs or between outputs

4. Simple Examples • Plant rootworm Bt corn or conventional corn with soil insecticide • Plant more corn and less soybeans • Rent an additional 100 acres for corn • Buy combine or continue custom hiring • Sell current tractor and buy a bigger one • Soil test for N or just use credits/guess

5. Partial Budget Basic Idea Benefits: 1) What will be the new or added revenues? 2) What costs will be reduced or eliminated? Costs: 3) What will be the new or added costs? 4) What revenues will be reduced or lost? Partial Budget: Answer these 4 questions and then calculate Net Benefit = Benefits – Costs

7. Planter Example • Look at buying a planter for 1000 acres of corn and soybean versus custom hire • What will be the new or added revenues? • Increased yields due to more timely planting • What costs will be reduced or eliminated? • No longer pay for custom planting • What will be the new or added costs? • Fixed and variable costs of owning planter • What revenues will be reduced or lost? • I can’t think of any

10. Planter Example • Only focused on costs and revenues that change • Made up numbers for illustration • Estimate 3 more bu of corn and 1 more bu of soybeans due to more timely planting • Corn = 1% loss/day in WI after May 8 • Soybeans: 0.25/bu/day in IA study • Estimate cost of owning and operating a planter: Use fast and simple method for 100 acres to get corn = $19.11/ac, soybeans = $20.38/ac • Custom rates: increased WI 2004 rates for increased fuel costs

11. Planter Example: What if “real” • Look at your records: How late was your custom planter over the last several years? • Estimate the average yield loss you suffered • Several equations for corn and soybeans on web • Cost to own and operate planter • Used the fast and simple method • Lower cost if use economic engineering • Is $6,755 ($6.76/ac) enough to justify the added hassle of owning and operating a planter?

12. Think Break #20 • Suppose you are a corn-soybean farmer who currently custom hires all combining. You are thinking of buying a combine. • Do a partial budget analysis of a Combine Purchase vs. Custom Hire decision • Needed assumptions/information and questions are given in the next slide

13. Think Break #20Combine Purchase vs. Custom Hire • Corn acres = 2,000; Farm crop acres 4,000 • Custom Rate = $25/ac • Scale Factor = 1.241 + (33.026/acres) • 1% yield increase with more timely harvest • Average yield = 150 bu/ac; Price = $4/bu 1) What will be the new or added revenues? 2) What costs will be reduced or eliminated? 3) What will be the new or added costs? 4) What revenues will be reduced or lost? 5) What’s the net benefit?

14. Another Example • Add 50 beef cows to your cow-calf herd • Convert 100 acres from grain to forage 1) What will be the new or added revenues? 2) What costs will be reduced or eliminated? 3) What will be the new or added costs? 4) What revenues will be reduced or lost? 5) What’s the net benefit?

15. Revenue Benefits 1) What will be the new or added revenues? • Sell more steers, heifers, and cull cows • 46 calves (92% efficiency) • Save 5 heifers as replacements (10% cull rate) • 23 steer calves: 500 lbs x $0.85/lb = $9,775 • 18 heifer calves: 460 lbs x $0.80/lb = $6,624 • 5 cull cows $500 each = $2,500 • Total = $18,899

16. Cost Benefits 2) What costs will be reduced or eliminated? • Variable inputs used for grain production • Fertilizer, seed, pesticides, etc.: $5,350 • Labor: $1,500 • Variable machinery costs: $1,000 • Interest on variable costs @ 6% = $470 • Total = $8,320

17. Cost Costs 3) What will be the new or added costs? • Fixed costs • Interest on cows and bulls = $2,500 • Bull depreciation = $300 • Variable costs • Labor = $600, Vet and health = $500 • Feed/Hay = $2,000, Pasture fertilizer = $1,500 • Hauling and Miscellaneous = $500 • Interest on variable costs @ 6% = $300 • Total = $8,200

18. Revenue Costs 4) What revenues will be reduced or lost? • Grain production from 100 acres • Corn: 110 bu/ac x $2.00/bu x 100 ac = $22,000 • Soybeans: 30 bu/ac x $5.00/bu x 100 ac = $15,000 • Use half of each, since 2 year rotation • Total = ½ ($22,000 + $15,000) = $18,500

20. Comments on Analysis • Needed more complete enterprise budgets for cow-calf and grain operations • Fixed cost added for cows and bulls, but no fixed cost change for crop conversion from grain to forage. Why? • Labor for cow-calf less than for grain ($600 vs. $1,500), an added benefit—What will you do with the extra time?

21. Comments on Partial Budgeting • Final comments on Partial Budgets • Economies of Size • Opportunity Costs • Sensitivity Analysis • Risk Changes

22. Economies of Size • Cause non-proportional changes in cost and revenue when make changes • Adding 20 cows to herd of 200 will increase labor demand, but less than 10% • Dropping 100 acres from 1000 acre grain farm will decrease costs, but less than 10% • Main Point: Linear (proportional) approximation is fine for small changes, but not for large—need more complete budgeting if large change

23. Opportunity Costs • Should be included in the analysis • Capital needs change: include costs (benefits) for borrowing more (less) money or tying up more (less) of your capital in farm assets • Labor and Management changes: include the costs/benefits of your and your family's time commitment changes • Change farm operation due to changes in credit or labor resources or desires

24. Sensitivity Analysis • Assumptions used to construct partial budgets not always known with certainty • Yield benefit for more timely planting • Crop yields and prices • Machinery costs • Run analysis with a range of assumptions • Low, average, high, worst or best case scenario • Find break even price or yield and decide how likely • Formally model the uncertainty: use probability distributions, decision trees, or pay off matrices and do risk analysis

25. Risk and Partial Budgeting • Partial Budgeting ignores changes in risk • Converting 100 acres from grain to forage and adding 50 cows to cow-calf operation: What are the risk implications? • Without formal “tools” comparisons ignore risk, or bring it in afterwards in ad hoc way • “The financial risk of owning a planter is too great to justify the $1,380 net benefit” • “The risk of not finding a custom combiner is too great to justify the $6,900 net benefit”

26. More Information • Partial Budgeting a common tool in ag, use Google • Extension Services in many states have bulletins or fact sheets • U of Maryland (posted) • Penn State (posted) • Colorado State, Virginia, Vermont, etc.

27. Summary • Explained and illustrated the purpose of partial budgets • Did examples, including Think Break #18 • Explained some issues/weaknesses of partial budgets (size economies, opportunity costs, sensitivity analysis, risk) • For problem set and exam: be able to make simple partial budget using given information and interpret findings