Budgets: Uses in Farm Management

1. Budgets: Uses in Farm Management Damona Doye OSU Extension Economist

2. Types of Budgets • Whole-farm • Enterprise • Partial

3. Whole-Farm Budget • Identify the resources available for use in production • Determine physical production data that will be used in the input/output process • Identify reliable prices (input/output) • Calculate expected costs and returns • Provides a plan for maximizing the returns to owned resources.

4. Enterprise Budgets • Provide an estimate of potential revenue, expenses, and profit for a single enterprise • Each type of crop or livestock is an enterprise • The base unit for crops is usually one acre • The base unit for livestock may be one head or some other convenient size

5. Partial Budgets • Focus on costs and benefits of alternative plans on a small part of the farm • Consider only the costs and returns that will change • Isolate the impact of change • Organize data to minimize the chances of overlooking something or counting an item twice

6. Why Budget?

7. Why Budget? • Planning • Evaluate options before you commit resources • Test economic and financial feasibility of alternatives (different enterprises, different production systems) • Estimate profits • Project cash flows • Estimate the size of farm needed to earn a specified return • Develop a production and marketing plan • Uncover costs that you may not have considered

8. Why Budget? • Implementation • Provide the documentation necessary to obtain/maintain creditworthiness • Estimate the amount of rent that can be paid for land or machinery • Identify production and financial risks and whether they may be managed • Monitor cash flows

9. Why Budget? • Control • Think of the enterprise budget as an enterprise specific “income statement” • Compare projected to actual results

10. Constructing an Enterprise Budget • Revenue • all cash and noncash revenue from production • Operating or variable expenses • all costs that would be incurred only if the crop/livestock is produced • Ownership or fixed expenses • costs that must be paid even if no crop/livestock is produced • Profit • return to all resources that were not charged in the budget (usually management)

11. Revenue • Crop • Yield • Price • Government payments • Crop insurance proceeds • Changes in inventory • Other sources • Livestock • Production: calves, pigs, milk, etc. • Price • Breeding herd replacements • Changes in inventory

12. (Operating) Variable Costs Livestock Budget • Feed • Veterinary and health • Repairs • Labor (operator and hired) • Interest on variable expenses Crop Budget • Seed, fertilizer, and chemicals • Fuel, oil, and lubricants • Repairs • Labor (operator and hired) • Interest on variable expenses • Other cash expenses

13. Fixed Costs • Machinery, equipment, building/facility • Depreciation • Economic useful life • Interest • Average investment (opportunity cost on funds) • Interest rate • Taxes and insurance • Land charge?

16. Interpreting and Analyzing Enterprise Budgets • An economic enterprise budget includes information on opportunity costs of labor, capital, land and perhaps management. • The profit (or loss) is what remains after covering all expenses, including opportunity costs.

17. Interpreting and Analyzing Enterprise Budgets • Returns Above Total Operating Costs • Production economically rational if total receipts minus total operating costs is greater than zero in the short run • Returns Above All Specified Costs • Return to management, risk, and land must be positive to survive in the long run

18. Budget notes • Many possible input levels and combinations. • Least cost input combinations should be incorporated into budget. • Fixed cost estimates are usually based on an assumed farm size or level of input use. • Unit of measurement • Time period • Multiple products

19. Other budget notes • Price and production assumptions • A budget to be used in next year’s plan should use an estimate of next year’s prices and production levels. • A budget that is used to make long range plans should use long-run estimates of prices and production levels. • Price received - ready markets or limited buyers? • Use budgets to conduct sensitivity • Average, best case, worse case yields or performance • Average, best case, worse case prices

20. Break-Even Analysis • What quantity of yield/price is required to cover wheat production costs? Operating costs $157.73 Fixed costs 31.37 Total costs $189.10 To cover variable costs: • $158 cost/33.4 bu = $4.72 break-even wheat price • $158 cost/$6 wheat price = 26 bu break-even yield To cover all costs : • $189 cost/33.4 bu = $5.66 break-even wheat price • $189 cost/$6 wheat price = 32 bu break-even yield

21. Sensitivity Analysis

22. OSU Enterprise Budgets As a part of Annie’s Project, you can select any 4 budgets free!

23. Summary: Enterprise Budgets • Organize projected income and expenses for a single enterprise. • Economic budgets will include opportunity costs in addition to cash costs and depreciation. • Can be used to compare the profitability of different enterprises and are useful for developing a whole-farm plan. Need to know cost of production to • Calculate break-even price • Develop marketing goals • Identify appropriate risk management strategies. Costs vary from farm to farm and year to year.

24. Two steps in partial budgeting: • Identify the impacts of change • Quantify the impacts GIGO = garbage in, garbage out

25. ? Net change associated with the decision = Partial Budget Format Positive Effect Additions to Income Added Receipts Reduced Expenses Total Additions Negative Effect Subtractions from Income Added Expenses Reduced Receipts Total Subtractions

26. ? Net change associated with the decision = Should I harvest or graze-out wheat? Positive Effect Additions to Income Added Receipts Reduced Expenses Total Additions Negative Effect Subtractions from Income Added Expenses Reduced Receipts Total Subtractions

27. Limitations of Partial Budgets • Only useful in comparing the profitability of two alternatives • Won’t tell you if a proposed change is the most efficient or profitable use of resources given all alternatives • Doesn’t account for time value of money • Data may not be readily available • Some things are hard to quantify

28. Sources of Budget Information • Actual farm records • Extension educators and specialists, educational materials, and meetings • Books on husbandry, industry • Producer organizations • Other producers • Internet sites • Agecon.okstate.edu/budgets • Budget Library in National Ag Risk Education Library: http://www.agrisk.umn.edu/Budgets/CustomSearch.aspx • Use third party sources with caution!

29. Budget Reminders • Match to your operation • List all relevant factors • Be reasonable in your estimates • Can be incomplete or unrealistic if adequate records not available • Include cash and non-cash costs where appropriate • Is it feasible? Cash flow vs. profit • Actual vs. planned - compare at regular intervals to see if problems are occurring