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Farm Management. Chapter 11 Partial Budgeting. 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.

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farm management

Farm Management

Chapter 11

Partial Budgeting

the use of partial budgeting in enterprise and farm planning partial budgeting
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.
when is it useful
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
slide4
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
uses of a partial budget
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.
steps in preparing a partial budget
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?
steps in preparing a partial budget1
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.
slide9
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.
partial budgeting procedure
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?
the partial budget format
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
problem 1
Added Costs

Reduced Returns

Sub Total

Added Returns

Reduced Costs

Sub Total

Change in Net Income

Problem #1
problem 11
Problem # 1
  • Use the following information to complete a partial budget.
problem 12
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.

problem 13
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.
problem 14
Problem # 1
  • Wheat is expected to be $3.60 per bu.
  • John’s Sprayer Wheels will cause 1/2 bu/acre loss of crop.
problem 15
Problem #1

Should John Custom Spray?

problem 16
Added Costs

1,000 x 4 = 4,000

1,000 x .15 = 150

Problem #1
slide22

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

slide23

Problem #1

Added Returns

2 x 3.60 x 1,000 = 7,200

Reduced Costs

Sub Total 7,200

slide24

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

partial budgeting examples
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.

factors to consider when computing changes in revenue and costs
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.

sensitivity analysis
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.

limitations of partial budgets
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.

final considerations
Final Considerations

Before adopting a proposed change

that appears profitable, additional risk

and capital requirements should be

considered.

summary
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.