Budget Analysis. Ag Management Chapter 4. Objectives*. Know the factors of production Understand what budgeting is and why it is important Demonstrate knowledge of budgeting principles, limitations of budgeting and guidelines for successful budgeting Know the steps in planning budgets
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Budget Analysis Ag Management Chapter 4
Objectives* • Know the factors of production • Understand what budgeting is and why it is important • Demonstrate knowledge of budgeting principles, limitations of budgeting and guidelines for successful budgeting • Know the steps in planning budgets • Identify the three types of budgets • Be able to develop and analyze an enterprise budget • Exhibit knowledge of partial budgeting
4 Factors of Budget Production • Capital • Labor • Land • Management • Must know the amount and value of each
7 Questions Managers Must Answer • What are available factors of production? • What is the best way to use available factors? • What crop and/or livestock enterprises are possible? • What proportion of the land should be used for each crop or livestock activity considered? • What labor is necessary? • What capital is needed? • What management and production practices should be used?
Budget • A plan for action by the business • Include projections of income and expenses for all or part of the business • Best format is a formal written plan
6 Reasons for Budgeting • Helps you plan for the useful life of assets • An excellent device for organizing • Useful to estimate the amount of credit needed from lending agencies • Allows for experimentation with possible outcomes before resources are actually committed • Identifies cost and income items that might be otherwise overlooked • Lets you refine an organization
Types of Budgets • Enterprise • Projected cost and returns for one production process usually for one production period • Ex: projected cost and returns per acre for a crop or per head for livestock • Partial • Projected cost and returns associated with some change in the farm or ranch business • Ex: A farmer analyzing a possible change from custom harvest to owning his own equipment • Cash Flow • Estimates of cash inflows and outflows for an entire production period • Ex: a monthly summary of projected cash receipts and disbursements for an entire year
Limits of Budgeting • Time • Difficult to accurately predict prices and yields • Risk both production and financial can limit the effectiveness of budget reliability • Overlooking cost and overestimating profits • Overestimating production
5 Guidelines to Make a Good Budget • Decide what you want to analyze with the budget • Decide whether to use enterprise or partial budgeting • Choose a time period for the budget. (Month, quarter or year) • Decide what data will be needed. • Decide how many alternatives will be evaluated or analyzed.
5 Steps to Develop a Budget • Appraise the business and family goals and objectives • Inventory resources available for use in the farm or ranch operation. • Inventory should consider the available levels of land, labor, capital and management. • Select the physical data for inputs and outputs • Select the market prices for inputs and outputs • Calculate the expected cost and returns.
Enterprise • Read p.4-4 to 4-10
Partial Budgets • Projected cost and returns associated with some change in the business operation
When Partial Budgets are Useful • Expanding an enterprise • Alternative enterprises • Changing production practices • Buying new equipment/machinery
Effects of Changes Positive • Reduced Cost (RC) • Change will reduce or eliminate some cost. Any cost that does not change will not be included • Additional Returns (AR) • Change will cause additonal returns. Any returns that will not change will not be included • Positive Effects= RC +AR • Additional Costs (AC) • Change will cause additional cost to be incurred. • Reduced Returns (RR) • Change will eliminate or reduce some returns • Negative Effects = AC + RR Negative
Net Change in Income • (RC+AR)-(AC+RR)= Net Change in Income • An estimate of the net effect of making a proposed change • Positive= indicates a potential increase in income due to the change • Negative= indicated a potential reduction in income due to the change
Cash Flow Budgeting • Projects money flow, reciepts and expenditures for a specific time, usually one year • For farms and ranches cash flow budget is projected on a monthly basis
Advantages • Shows the operator where excess cash will be available and when cash deficits will occur • Provides for budgeted loans that are borrowed only for the periods through which they are required • Provides a technique for combining personal and farm or ranch financial needs for the next period • Allows comparison of cash flow projections with the cash flow summary to record actual performance against the advanced planning • Helps evaluate the relationship between short-term debt to repayment capacity • Lets the manager immediately see the cash position through the year
Disadvantages • Time must be devoted to collecting and projecting data • Projected prices are difficult to estimate • Borrowing rates may fluctuate • Family and business consumption of resources may vary • The entire cash flow projection plans need constant review and revision
Summary* • Cash flow planning is a tool the farm or ranch can use to analyze trends in the farm business • Allows a manager to analyze a net cash projection and borrowing requirements • Used to establish credit lines necessary to the farm business • Cash flows must be constantly evaluated and updated • Cash flows are only as good as the information used
Assignment • Complete Assignment Sheets 1-3 & Ch 3 and Ch 4 Review Sheets. • Due--