INTRODUCTION
Questions of how to best organize
and manage the FARMER business in a manner consistent with the goals and
objectives of the FARMER family must be continually addressed. The decision as
to whether the considered alternatives are consistent with established goals
and objectives rests upon the FARMER and the FARMER family acting as the
manager if no outside management is hired.
The agricultural producer or FARMER
manager is challenged when organizing and managing FARMER resources to maximize
economic returns to owned or controlled resources. Resources include Land
(Owned and rented) and associated improvements, capital assists such as
machinery and breeding livestock (Borrowed and owned), and labor (hired, FARMER
operator, and additional family). The manager is responsible for combining
available resources and knowledge to best achieve the desired goals and
objectives of the FARMER business.
DEFINITION OF BUDGET
Budgets according to English
dictionary is a plan for allocating resources; a plan specifying how resources,
especially time or money, will be allocated or spent during a particular
period.
The technique and process for
developing and analyzing alternatives for decision making is called budgeting.
It is a formal quantitative presentation of worker research to go into. It is a
planning process, it involves input and output relationship.
Budgeting is a management tool that
can provide information to answer a multitude of questions if used properly.
Combining inputs into products, allocating resources to alternative products,
and choosing combinations of different products are choices whose consequences
can be analyzed efficiently through the use of he budgeting tool.
With budgets, management can to
answer such questions as:
- How may
the available resources best be used?
- What enterprises (Crops and/or
livestock) can be produced and which will contribute most to returns to owned
resources?
- How much of the controlled land
should be devoted to each enterprise?
- What equipment and machinery will be
needed to produce the potential enterprises?
- What production practices should be
used to produce each of the enterprises.?
- How much labour (both family and
hired) will be needed on the FARMER?
- What are the capital requirements?
FARMER management skills and
knowledge are an integral part of financial success.
Resource
Allocation
The problems of resource use and
allocation involve the application of five economic principles. These
principles, in a simplified form, consist of:-
- Adding units of an inputs as long as
the value of the resulting output or added returns is greater than the added
cost.
- Substituting one input for another as
long as the cost of the added input is less than the cost of the input that is
replaced and the output in maintained.
- Substituting one product for another
as long as the value of the added output is greater the value of the output
that is replaced and the cost is constant.
- Using each unit of resource where it
gives the greatest returns when resources are limited.
- Basing comparisons upon discounted
valued when considering different time periods and/or laments of risk.
The first three principles relate to
situation where un-limited resources are availed for use of the manager with
perfect knowledge. The last two relate to situations where there are limited
resources and when there is not perfect
knowledge.
Most resource allocation management
problems faced by FARMER managers can be addressed by applying the basic
budgeting economic principles. Numerical calculations to assist in making
management decisions. No type of budget I s tied to any particular principle.
The type of budget relates to the intent of the analyses, while the principles
relate to the FARMER resources and the resources relationships that exist.
TYPES OF BUDGET
There are three types of budgets that can be used in
the FARMER business management process. Common thread in each type is that, if
properly defined and used, the budget format permits the manager to use economic
logic to answer question of what, how much and when resource should be used to
achieve the goals and objectives as established by the FARMER family.
The
tree types of budget are:-
1. whole- FARMER budget
2. Enterprise
budget
3. Partial budget
BRIEF
DEFINITION OF THE TREE TYPES OF BUDGETS
The whole-FARMER budget:- is
a classified detailed summary of the major physical and financial feature of
the entire FARMER business. Whole FARMER budgets identify the component part of
the total FARMER business and determine the relationships among the different
parts, both individual and as a whole.
An Enterprise budget:- is a statement of what generally is expected from a
set of particular production practices when producing a specified amount of
product. It consist of a statement of the production of a particular product. An
enterprise budget documents variable and fixed cost. It is useful in
calculating profitability and break- even values.
The partial budget:- is useful in analyzing the effects of a change from an
existing plan. This budget only considers revenue and expense items that will
change with a defined change in the plan.
But for the course of this
assignment let us focus on Enterprise and partial budget.
ENTERPRISE BUDGETS
An enterprise is defined as a single crop or livestock
commodity being produced on a FARMER and most FARMER consist of a combination
of several enterprise. An enterprise budget is a listing of all estimated
income and expenses associated with a specific enterprise to provide and estimate
of it’s profitability. One can be developed for each actual or potential
enterprise in a FARMER plan such as the corn enterprise, wheat enterprise, or a
cow/calf enterprise. Each is developed on the basis of a small common unit such
as 1acre for crop or 1 head for livestock. This permits easier comparison of
the profit for alternative and competing enterprises. There are several and
difference between crop and livestock enterprise budget and each will be
discussed separately.
Crop
Enterprise Budgets:
Enterprise
budgets can be organized and presented in several different formats but they
typically contain three sections: Income, Variable cost, and Fixed cost.
The first step in developing an
enterprise budget is to estimate the total production and the expected output
price. Both of these values will obliviously have a great effect on enterprise
profitability and they should be carefully estimated. The estimated yield
should be the average yield expected under normal weather conditions given the
soil type and input levels to be used. Input levels must be considered because
seceding rates, fertilizer levels, chemical use, and tillage practices all
affect yield. Since enterprise budgets are used for forward planning or making
future plans, the output price should be the manager’s best estimate of the
average respected during the next year or next several years depending on the
planning horizon.
Variable
costs are estimated next, and some, such as for seed, fertilizer to be used to
obtain. Other variable costs such as
fuel, machining repairs and labor are more difficult to estimate, particularly
on a per acre basis these costs depends on machining type and size and the
number of tillage operations to be performed,
T able 1: Example Enterprise Budget
for corn production (IAcre).
Item
|
Value
per Acre
|
Income
|
|
120
business at
|
|
Variable
costs
|
|
seed
|
|
Fertilizer
and time
|
34,50
|
chemicals
|
16.00
|
Machinery
fuel and repair
|
22.50
|
Dry expenses
|
12.00
|
Hauling
|
6.00
|
Labor
at
|
22.00
|
Miscellaneous
|
4.00
|
Interest
on variable cost (10%for 6 month)
|
6.45
|
Total
variable costs
|
|
Income
above variable costs
|
|
Fixed
costs
|
|
Machinery
depreciation, interest, taxes and insurance
|
|
Land
change
|
100.00
|
Total
fixed costs
|
|
Total
cost
|
|
Estimated profit
|
As
shown in the table 1, enterprise budgets include a change for the opportunity
cost on capital invested in the variable cost. Thos change covers the time
period between expenditure of the capital and harvest when the income is or can
be received.
In this example an average time
period of 6 months is assumed and a 10 percent opportunity cost is changed on
the N 129 of variable costs for 6
months which amounts to N6.45. The
estimated total variable cost is N
135.45, making the income above variable cost equals N140.55.
The fixed cost in a crop enterprise
budget are those associated with Machinery plus a change for Land use.
Machinery fixed cost include those discussed in the cost concept, but they must
be prorated to the specific crop enterprise on a per acre basis the amount of
machinery fixed cost will depend on the size, age, and number of machines used
in producing the crop as well the tillage practices used. Those costs are often
difficult to estimate unless all machinery work is hired on a custom basis.
The Land change is the opportunity
cost of land and represent a return for it’s use in crop production. There methods
can be used to determine a land change.
(I) an interest opportunity cost based on
the current value of the Land; (ii) the
owner’s rental income from a typical crop share lease, or (iii) a typical cash rent change. In the first method,
the land change would be the opportunity cost of capital times the current land
value. For eg; 10 percent times a land of N1,500
per acre would result in annual land change of N150 per acre. The share rental method would include the value of
the owner’s share of the crop less any crop production expenses paid by the
owner.
Most crop enterprise budgets base
the land change on one of the above rental methods for several reasons. First,
it is the appropriate charge production. Second is a chilly being rented for
crop the rental income represents the land is owned, the only feasible
alternative to an owner’s operator is to someone else.
Another reason is related the rapid
increase in land values in recent years and the psychology of land ownership. A
land change based on the actual opportunity cost of capital and current land value
results in a land charge considerably higher than on an investment in land.
This indicates people own land for reason other receiving a high current return
on their investment. Examples would be personal satisfaction and prestige pride
of ownership, and anticipation of continued inflation in land value.
Interpreting
Enterprise Budget:-
The
enterprise budget for corn production presented in the table 1 shows an
estimated profit of N4.55 per acre above
all costs. However, this may not be the maximum profit possible from an acre of
the any enterprise budget represents only one point on a production function.
For example, changing the fertilizer level would change its cost, the yield,
total income and therefore the expected profit. Strictly speaking, there is an enterprise
budget for every point on a production function; so as budget does not
automatically determine the profit-maximizing input levels. This should be done
prior to completing the enterprise budget, with the resulting input levels then
used to complete the budget.
The estimated profit can be compared
against the estimated per acre profit for ot6her crops and used to select the
more profitable crops and crop combination to be grow each year. However, the
profit figures must be properly interpreted, as they are the return or profit
above all cost including opportunity cost on owned inputs.
If review the figures in the table
1. again we will notice that there is a change for al purchased inputs as well
as an opportunity cost on capital used for variable costs, a N4 an hour change on all labor whether
hired or operator labour, opportunity cost on the investment in machinery, and
a land charge. The estimated N4.55 per
acre profit is a time return above all costs and might be thought of as a
“pure” profit. Viewed another way, any enterprise budget with an estimated
profit of zero is not as bad as it might seem at first. All labor required on
the enterprise would be earning an hourly rated equal to the budgeted rate and
all required capital would be earning it’s opportunity cost.
The enterprise budget in Table 1 is
typical in that there is charge for all
inputs used with one exception; there is no charge for management. Therefore,
another interpretation of the estimated profit is to consider it a return to
management or payment for the management input. Some budget formats use Return
to management instead of Estimated profit to label the last time.
Break-even
Analysis:- Enterprise budgets can be used to perform a breakeven analysis
for either prices or yields. The formula for calculating the breakeven yield is
Break-even
yield= total costs
Output price.
This
is the yield necessary to just cover all costs at a given output price. For the
example in Table 1. it would be N271.45
:- N2.30, or 118.0 bushels per acre.
Since the output price is only an estimate of the expected price. The
break-even yield can be calculated for a range of possible price as shown
below.
Price
per bushel
|
Break-even
yield, bushels
|
1.90
|
142.9
|
2.10
|
129.3
|
2.30
|
118.0
|
2.50
|
108.6
|
The
break-even pri9ce, or the price necessary to cover all cost at a given yield
level, can be found from the equation.
Break-even price= total cost
Expected
yield.
Continuing
with the same example, the break-even price would be N271.45 :- 120 bushels, or N2.26
per bushel. The break-even price can laso be calculated for a range of possible
prices as shown bellow:-
Yield,
bushels
|
Break-even
price
|
80
|
3.39
|
100
|
2.71
|
120
|
2.26
|
140
|
1.94
|
Since
both the yield and output price in an enterprise budget are estimated rather
than actual values, the calculation of break-even yields and price can aid
managerial decision making. By studding the various combinations of break-even
price and yields, managers can form their own expectations about the probability
of obtaining a price and yield combination which would just cover total costs.
Notice that break-even price and yields can also be calculated based on total
variable costs. The results can help make the type of decision discussed in
cost concept on whether to produce or not in order to minimize losses in the
short run.
Cost
of Production: cost of production is
a term used to describe the average cost of producing one unit of a given
product. It is equivalent to the concept of average total cost discussed cost
concept, provided that the same cost and yield are used to calculate each. The
cost of production concept is becoming important for several reasons. Including
the setting of price support level for government FARMER programs.
The estimated cost of production is
found by dividing the total cost per acre by the estimated yield for the
example in the table 1, the cost of production for corn would be N271.45 divided by 120 bushels, or an
estimated N2.26 per bushel. Notice that
the cost of production is the same as the break-even price. As with the
break-even price, the costs of production will change not only with changes in
the estimated cost but with changes in yield while cost of production is becoming
a widely used concept, any value is only as good as the cost and yield
estimates used in the computations. Because of many difference in costs and
yields, the actual cost of production for any crop is likely to be different
between FARMERs, countries, regions, and states.
Livestock enterprise Budget:-
Budgets
for livestock enterprise follow the same general format as crop budgets but are
often more difficult to complete. First, there is the problem of accounting for
multiple outputs such as calves and cull Cows for a beef cow enterprise: Milk,
Calves, and cull cows for a dairy enterprise: and Lambs, wool, and cull ewes
for Sheep enterprise for the cost of raising or purchasing replacement animals
to maintain a breeding heard over time, and thirdly is the problem of the
valuation of FARMER-raised feed fed to the animals. The latter problem is
particularly difficult in the case of pasture and crop residues, which may have
little or no value if not used by livestock.
THE PARTIAL BUDGET CONCEPT
Partial budgeting is a procedure where receipts and
expenses which increase with a change in organization or procedures are listed
in a systematic order. It is a process to allow a total FARMER budget to be
fine- turned. It focuses on the analysis of a defined change to see if it
improves the total FARMER budget; a partial budget is used to calculate the
expected change in profit for a proposed change in the FARMER business. It
differs from an enterprise budget in that several enterprises might be involved
in the change, but a partial budget is not suitable for preparing a plan for
the whole FARMER. Partial budgeting is therefore intermediate in scope between
enterprise budgeting and whole FARMER planning. It is useful to think of
partial budgeting as a type of marginal analysis, as it is best adapted to
analyzing relatively small changes in the whole FARMER plan.
A partial budget contains only those
income and expense items which will change if the proposed modification in the FARMER
plan is implemented. Only the changes in the income and expenses are included
and not the total values. The final result is an estimate of the gain or
loss in profit. To make this estimate, a
partial budget systematically organizes the answers to four questions relating
to the proposed change:
1. What new additional cost will be
incurred?
2. What current income will be lost or
reduced?
3 What new or additional income will be
received?
4. What current cost will be reduced or
eliminated?
The first two questions identify
changes which will reduce profit by either increasing cost or reducing income. Similarly,
the last two question identify factors, which will increase profit by generating
additional income or lowering cost.
The steps in constructing a partial
budget are:
1. State the proposed alternative or
change there will be analyzed.
2. Collect data on all aspects of the
business that will be affected by the change.
3. Classify or group the types of impacts
that will occur by including expenses increased or reduced and receipts increased
or reduced.
The partial budget concept is based
on fact that a change in the organization of the business will have one or more
of the following effects:-
Positive
Economic Effects
- The change will eliminate or reduce some costs.
- The change will increase returns.
Negative
Economic Effects:-
- The change will cause some additional
costs
- The change will eliminate or reduce some
returns.
The net change between positive and
negative economic effects is an estimate of the net effect of making the
proposed change in the total FARMER budget. A positive net change indicates a
potential increase in income and a negative net change indicates a potential reduction
in income due to the proposed change.
A partial budget can be used to
analyze a long – run change such as buying or renting an additional 160 acres
or a short run change such as altering the crop rotation for 1 year in response
to weather or price changes. Changes in the FARMER plan or organization adapted
to analysis by use of a partial budget are of three general types.
1. Enterprise
substitution:- This includes a complete or partial substitution of one
enterprise for another. Examples could include substituting 80 acres of soybeans
for 80 acres of corn, substituting alfalfa for all the current barley
production, or replacing the beet cow herd with a stocker steer enterprise.
2. Input substitution
or level: change s involving the substitution of one input for another or the
total amount of input to be used are easily analyzed with a partial budget.
Example would include subsisting machinery for labor by purchasing larger
machinery, changes in livestock feed rations, owning harvesting equipment
instead of hiring a custom operator, and increasing or decreasesing fertilize
or chemical usage.
3. Size or scale of operation. Included in
this category would be changes in total size of the FARMER business or in the
size of a single enterprise. Buying or renting additional land. Purchasing
additional beef cows, or expanding the swine enterprise would be examples.
These three types of changes are not
mutually exclusive, as many single proposal might include a combination of two
or more.
The partial budget format
Table 2 format for partial budgeting
Partial
budget
Proposed
change
Additional
cost(&) Additional
income(&)
Reduced
income(&) Reduced
costs (&)
A
total annual additional costs B Total
annual additional income
and
reduced income and
reduced costs
a
widely used format for partial budgeting is shown in table 2 other forms with a
slightly different organizational are also used, but all contain four basic
headings to organize the information relating to the four questions presented
in the last section.
- Additional costs: a proposed change
may cause additional costs because of a new or expanded enterprise requiring
the purchase of additional inputs, or a new input will be purchased as a
substitute for another. Any additional fixed costs should be included as well
as additional variable costs. If the proposed change requires the purchase of
new machinery, buildings, land or breeding livestock, there will be additional
fixed costs. These should be average
annual values: so depreciation should be computed using the straight-line
method. Opportunity cost on any new capital investment should also be included
as an additional fixed cost.
- Reduced income: income may be reduced
if the proposed change would eliminate an enterprise, reduce the size of an
enter praise, or cause a reduction in yield or production levels. Proper
estimation of reduced income requires careful attention to estimating average
yields. Production levels or changes in these value as well as output prices.
- Additional income: a proposed change
may cause an increase in total FARMER income, if a new enterprise is being
added. If an enterprise is being expanded, or it the change will cause yields
or production levels to increase. As with all parts of a partial budget only
the additional income expected as a result of the proposed change is listed under this section and not
the total income. Accurate estimates of output prices and yields are important
for completing this section, as they were for estimating reduced income.
- Reduced costs: both fixed and
variable costs may be reduced by the proposed change. The fixed costs of
depreciation and interest or opportunity cost on the investment will be reduced
if the change results in eliminating or reducing the investment in machinery,
equipment, buildings, breeding livestock, or land. In addition, variable costs
will be reduced if an enterprise is eliminated or reduced in size or there is
some change in a production technique or method which decreases the need for
variable inputs. The reduced costs associated with lower labor requirements
must be carefully evaluated costs will be reduced only if less total labor is
hired and the total cost of labor decreases. When all labor is provided by he
manager and full time employees, the total labor cost will remain the same
unless one less employee is needed. Often proposed changes which reduce labor need
by several hundred hours per years do not actually reduce labor costs because
the full-time labor force is unchanged. However, if the labor released by the
proposed change can be profitably used in another enterprise, any additional
income generated should be included as additional income in the analysis
example of partial budgeting.
Table
3: partial budget wheat graze out versus harvest for grain
Situation:
should I leave stoker on wheat pasture for 60 days rather than remove stockers
and combine wheat.
Additional
cost’
|
Additional
returns
|
||
Interest
on investment
Addition
vet, feed etc
|
$8.00
$3.00
|
Steers:
760 1bsx1.54/1b. &1,216.60
|
|
Reduced returns
Steers: 640ibs.x 1.61/1b
|
$1,030.40
|
Reduced
cost harvesting
&.21/1+(N0.21/bu.x
15)
|
$24.15
|
Wheat
sales:
35bu.x$7.50
ibu
|
262.50
|
Hauling
&0.22x35
bu/acre
|
7.70
|
Total annual additional cost and reduced returns
|
&1,303.90(A)
|
Total
annual additional returns and reduced costs
|
&1,248.45(B)-1,303.90(A)
|
Net
change in income(B-A) $ -55.45
|
Summary
Budgets (whole-FARMER, enterprise and partial are
management tools to help evaluate the FARMER business. Each type of budget has
a different but related purpose and should because by managers accordingly.
Whole FARMER budget becomes a starting point that can be used to analyze the FARMER
business over time. Enterprise budgets can be used to analyze components of the FARMER business and
also be a building block for the whole FARMER. One a whole FARMER budget has been developed, a
partial budget can be valuable in evaluating changes to the total FARMER
budget. Each type of budget offers useful information to support management
decisions.
References
FARMER
management
Planning,
control and implementation Ronald d. Kay
Texas
A & M university
International
students edition
Copy
right© 1981
Exclusive
rights by McGraw-hill Book company Japan, Ltd. For manufacture and export. 2nd
printing 1983.
Agricultural
finance and management S. subba reddy’
P.
Raghu Ram
Oxford
& INH publishing co. PVT
Ltd
New Delhi
©
1996, s. subba Reddy and P. Raghu Ram.
Oklahoma
cooperative extension services fact sheets AGEC-139
Oklahma
state university
Damona
doye
Regents
professor and Extension economist