Enterprise Budgeting Chapter 10

1. 1 Enterprise Budgeting(Chapter 10)

2. 2 Objectives Define an enterprise budget. Illustrate the different sections of an enterprise budget. Learn how to construct an enterprise budget. Show how to compute cost of production, break-even prices, and break-even yields.

3. 3 What is Budgeting? �Analyzing something on paper.� A way to estimate: Profitability Feasibility Impacts of changes Remember analyzing alternatives in management decision-making as part of the planning function?

4. 4 What is an Enterprise? An individual crop or type of livestock: Wheat Dairy Can also look at alternative Corn production methods for Apples a single enterprise: Beef cows - example is conventional tillage Etc. of wheat versus no-till wheat A farm�s production plan will often consist of several enterprises.

5. 5 Enterprise Budgets For a single enterprise: Potatoes, Wheat, Beef cows, Dairy cows An organization of: Revenue Expenses Profit Base units: Crops = 1 acre Livestock = 1 head Why a standard base unit??

6. 6 Purpose of an Enterprise Budget Estimate costs, returns, and profit per acre or per head. Help identify more profitable enterprises. �Building blocks� of the whole farm plan.

7. 7 Estimated Economic Profit Most enterprise budgets are economic budgets (guess what cost is included??). Opportunity costs are included: Operator labor. Capital used for variable costs. Capital invested in machinery. Capital invested in land. Return to management often omitted due to difficulty of estimating.

8. 8 Types of Costs Variable Costs are from actual operation of the enterprise: Operating costs Direct costs Assignment is relatively easy. Fixed Costs are from owning machinery, buildings, land: Ownership costs Indirect costs Difficult to assign: Prorated to individual enterprises.

9. 9 Opportunity Cost of Management Often left off of the enterprise budget: As mentioned, difficult to estimate. If left off: The estimated profit should be interpreted as �estimated return to management and profit.�

10. 10 Constructing an Enterprise Budget Determine management and production practices, inputs, and input levels. Enterprise budgets require a lot of data: Past records. Price and yield data. Research conducted by Universities: Average yields, input requirements.

11. 11 Revenue All cash and noncash revenue. Estimate yields and prices as accurately as possible. Projected yields should be based on: Historical yields, yield trends, type & amount of inputs used. Selling prices should be based on: Historical price levels, price trends, price forecasts. Adjusted for known selling expenses.

12. 12 Operating (or Variable) Expenses Cost that will be incurred only if the product is produced.

13. 13 Variable Expenses Seed, Fertilizer, and Chemicals Determine input levels. Contact suppliers for prices. Find the total per-acre cost.

14. 14 Variable Expenses Fuel, Oil, and Lubrication Divide the total farm expense for fuel, oil, and lube by the number of crop acres: Not as accurate if machinery is used for other enterprises (crops with unequal use or livestock). Determine the fuel consumption per acre for each machine operation. Determine the fuel consumption per hour of tractor use.

15. 15 Variable Expenses Machinery Repairs Divide the total farm repair expense by the number of crop acres: Not as accurate if machinery is used for other enterprises (crops with unequal use or livestock). Determine the repair expense per acre for each machine operation. Determine the repair expense per hour of tractor use.

16. 16 Variable Expenses Labor Depends on the size of the machinery used and the number of machine operations. Include the time to: Operate machinery in the field as well as going to and from fields. Adjust and repair machinery. Irrigation and other tasks. Use opportunity cost for farmer�s labor? Cost of hired labor + fringe benefits? Separate out the two?

17. 17 Variable Expenses Interest Interest on capital tied up in operating expenses. Charged for a period less than 1 year: From the time operating costs are incurred until harvest. Use opportunity cost if farmer�s own capital.

18. 18 Variable Expenses Interest � An example for winter wheat Planting/fertilizer costs in October = $60.00 per acre Fertilizer/spraying costs in April = $40.00 per acre Harvesting costs in early September = $30.00 per acre Interest rate = 10% Wheat sold after harvest in mid-September.

19. 19 Variable Expenses Interest � An example for winter wheat Planting/fertilizer costs in October = $60.00 per acre Fertilizer/spraying costs in April = $40.00 per acre Harvesting costs in early September = $30.00 per acre Interest rate = 10% Wheat sold after harvest in mid-September What is interest cost per acre?

20. 20 Variable Expenses Interest � An example for winter wheat Planting/fertilizer costs in October = $60.00 per acre Fertilizer/spraying costs in April = $40.00 per acre Harvesting costs in early September = $30.00 per acre Interest rate = 10% Wheat sold after harvest in mid-September What is interest cost per acre? (60+40+30) x 0.10 = $13.00 ??

21. 21 Variable Expenses Interest � An example for winter wheat Planting/fertilizer costs in early October = $60.00 per acre Fertilizer/spraying costs in early April = $40.00 per acre Harvesting costs in September = $30.00 per acre Interest rate = 10% Wheat sold after harvest in mid-September. What is interest cost per acre??

22. 22 Income above Variable Costs Often called: Gross margin Shows how much an acre will contribute toward paying fixed or ownership expenses. Shows how much revenue could decrease and still cover variable or operating expenses: Important to know variable costs??

23. 23 Ownership or Fixed Expenses Costs that would exist even if the crop wasn�t grown. Costs incurred due to ownership: Machinery Equipment Land

24. 24 Fixed Expenses Machinery Depreciation Depends on the size and type of machinery. First compute annual depreciation. Convert to a per-acre or per-hour value based on acres or hours used. Prorate to a specific enterprise.

25. 25 Fixed Expenses Machinery Interest Based on the average investment in the machine over its life. Doesn�t matter how much, if any, money was borrowed to purchase it. Find the annual average interest charge: Interest = Cost + Salvage value X Interest rate 2 Prorate to each enterprise.

26. 26 Fixed Expenses Machinery Taxes and Insurance Allocate the annual expense to each enterprise based on use.

27. 27 Fixed Expenses Land Charge What it would cost to cash rent similar land. The net cost of a share-rent lease for this crop on similar land (note example handout). For owned land � the opportunity cost of capital invested in the land: = the value of an acre X the opportunity cost of the owner�s capital.

28. 28 Fixed Expenses Miscellaneous Overhead Used to cover many shared expenses: Pickup expense. Liability insurance. Shop expenses. Expenses that can�t be directly associated with a single enterprise.

29. 29 Profit or Return to Management Total revenue less total expenses. If a charge for management hasn�t been included: Return to management and profit. Management is an economic cost and should be recognized: As as specific expense. As part of the residual net return or loss.

30. 30 UI Enterprise Budgets(CAR) Look at example handout: Soft white winter wheat in N. Idaho Background and assumptions (pg. 1). Actual budget (pg. 2). Monthly summary of activities and Machinery/Equipment costs (pg. 3). Sensitivity analysis (pg. 4).

31. 31 Livestock Enterprise Budgets Unit Usually 1 head 1 litter 1 cow unit 100 birds

32. 32 Livestock Enterprise Budgets Time Period Most are 1 year. Some feeding and finishing enterprises require less than 1 year. Important that all costs and revenue in the budget be calculated for the same time period.

33. 33 Livestock Enterprise Budgets Multiple Products All sources of revenue must be prorated to an average individual animal: $ Cull cows $ Calves Average cow $ Milk

34. 34 Livestock Enterprise Budgets Breeding Herd Replacement If raised, the number of female offspring sold must be adjusted. If purchased, show revenue from selling all female offspring. Including the net cost of replacements: An annual depreciation charge (straight line). The purchase cost of a replacement divided by the useful life can be shown as an expense, and the revenue from culled animals divided by useful life can be shown as revenue. Both give the same value.

35. 35 Livestock Enterprise Budgets Feed and Pasture Purchased feed is valued at cost. Raised feed should be valued at its opportunity cost (what it could be sold for). Pasture costs include the cost of renting or its opportunity cost if it is owned. Don�t forget things like: Salt and minerals. Annual charges for establishment costs. Fertilizer on pasture. Spraying or mowing of pastures. Feed needed to maintain replacements.

36. 36 Livestock Enterprise Budgets Livestock Facilities Buildings, fences, pens, chutes, feeders, watering equipment, wells, feed storage, milking equipment Variable costs include: Repairs, fuel or electricity. Fixed costs include: Annual Depreciation, Interest, Taxes, Insurance. Find the per head fixed cost. Allocate fixed costs among all enterprises if applicable.

37. 37 Livestock Enterprise Budgets Machinery and Equipment Divide operating and ownership expenses between crop and livestock enterprises: Tractors. Pickups. Other machinery and equipment.

38. 38 Enterprise Budgets(CAR) Look at example handout for livestock: Cow/calf operation for 250 cow herd. Background and assumptions (pg. 1). Actual budget (pg. 2). Monthly summary of returns/expenses and feed requirements (pg. 3). Investment summary (pg. 4): Note allocation of equipment.

39. 39 Interpreting & Analyzing Enterprise Budgets Economic budget: Includes opportunity costs on labor, capital, land, and even management. Economic Profit vs. Accounting Profit A projected economic profit of zero isn�t as bad as it might seem: Labor, capital, land are just earning their opportunity cost.

40. 40 Cost of Production The average cost of producing one unit of the commodity. Cost of Production = Total Cost Yield A profit is made when the product can be sold for more than its cost of production. Same thing could be done for TVC!

41. 41 Break-Even Analysis Break-Even Yield: The yield necessary to cover all costs at a given output price. Break-Even Price: The output price needed to just cover all costs at a given output level.

42. 42 Break-Even Yield The yield necessary to cover all costs at a given output price: Break-even yield = Total cost Output price

43. 43 Break-Even Price The output price needed to just cover all costs at a given output level: Break-even price = Total cost Expected yield

44. 44 Summary Enterprise budgets are constructed for a single unit of the enterprise: 1 acre or 1 head They include variable and fixed expenses as well as opportunity costs. They are the building blocks of the whole farm plan. They can be used to compare the profitability of alternative enterprises. Enterprise budgets contain the data needed to compute cost of production, break-even yield, and break-even price.