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ABM 231 Farm Management 1

Farm Budgeting

Budgeting can be used to select the most profitable plan from among a number of

alternatives and to test the profitability of any proposed change in plan. It involves

testing a new plan before implementing it, to be sure that it will improve profit.

Farm budgeting is a method of estimating expected income, expenses and profit for a

farm business.

Types of Farm Budgets

1. Enterprise budget

An enterprise is defined as a single crop or livestock commodity being produced on

the farm. An enterprise budget is an estimate of all income and expenses associated

with a specific enterprise and estimate of its profitability.

Enterprise budget can be developed for each actual and potential enterprise in a farm

plan such as paddy enterprise, wheat enterprise or a cow enterprise. Each is developed

on the basis of small common unit such as one acre or one hectare for crops or one

head for livestock. This permits easier comparison of the profit for alternative and

competing enterprises.

Enterprise budget can be organized and presented in three sections income, variable

costs and fixed costs.

The first step in developing an enterprise is to estimate the total production and

expected output price. The estimated yield should be an average yield expected under

normal weather conditions given the soil type and input levels to be used. The output
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price should be the manager’s best estimate of the average price expected during the

next year or next several years.

Variable costs are estimated by knowing the quantities of inputs to be used (such as

seed, fertilizer, labour, manures) and their prices.

The fixed costs in a crop enterprise budget are depreciation on machinery, equipment,

implements, livestock, farm building etc., rental value of land, land revenue, interest

on fixed capital.
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Example: Enterprise Budget for Paddy Production (One Hectare)

I) INCOME ZMW
5000Kgs @ ZMW. 8,000 per ton 40,000
II) VARIABLE COSTS
1. Human labour 9,000
a) Owned 3,000
b) Hired 6,000
2. Bullock labour 500
a) Owned 200
b) Hired 300
3. Tractor power 4,000
a) Owned 1,000
b) Hired 3,000
4. Seeds 1,700
5. F.Y.M. 1,800
6. Green leaf manures 700
7. Fertilizers 3,000
8. Plant protection chemicals 700
9. Irrigation charges 500
10. Interest on working capital 1,700
Total variable costs 24,300
III) FIXED COSTS
1. Depreciation 1,900
2. Rent on owned land (Rates) 3,500
3. Interest on fixed capital 1,450
Total fixed costs 6,850
Total costs 31,150
Gross margin (T.R. - T.V.C.) 15,700
Profit (T.R.-T.C.) 8,850
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2. Partial Budget

It is used to calculate the expected change in profit for a proposed change in the

farm business. Partial budget is best adopted to analysing relatively small change in

the whole farm plan.

Use of partial budgets are of three types.

1. Enterprise substitution: This includes a complete or partial substitution

of one enterprise for another. For example, substitution of sunflower for

groundnut.

2. Input substitution: Example: Machinery for labour, changing livestock

rations, owning a machine instead of hiring, increasing or decreasing fertilizers or

chemicals.

3. Size or scale of operation: This includes changing in total size of the

farm business or in the size of the single enterprise, buying or renting of

additional land, expanding or decreasing an enterprise.

The partial budget format

1. The contents of the partial budget will comprise items of income, which will

increase: what new or additional income will receive? A proposed change may cause

an increase in total farm income if a new enterprise is adding, if an enterprise is being

expanded, or if the change will cause yields or production levels to increase.

2. Items of income which will decrease what current income will be lost or reduce?

Income may be reduced if the proposed change would eliminate an enterprise, or

cause a reduction in yield or production levels.

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3. Items of expenditure which will decrease what current costs will be reduced or

eliminated.

4. Items to be incurred? A proposed change may cause additional costs to increase

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.

5. Net increase or decrease in profit.

Gain Cost

A. Additional Revenue/Income: D. Reduced Revenue/Income:

Expected additional returns that would accrue Returns that will no longer be received

from the change under consideration after the change has been made

B. Reduced Costs/Expenses: E. Additional Costs/Expenses:

The savings in cost which will no longer be Additional direct costs that would occur

incurred if the changes are made in year’s business as a result of the

change.

C. Total gain: Additional Revenue (a) plus F. Total Cost: Reduced Revenue (d) plus

Reduced Cost (b) Additional Cost (e).

No change (change in net income): the difference between total gain (c) and total cost (f) is

net farm income. A positive difference indicates that the proposed change plan has higher

expected net income than the base plan and vice versa.

Example1: Supposing the addition of 50 beef cows to an existing herd needs additional 60

hectares of forage, which is currently in grain production and will have to be converted to forage
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production. There will be additional fixed costs including additional interest on the increased

investment in beef cows, depreciation on bulls and additional property taxes. Herd replacements

are assumed to be raised, so there is no depreciation included on the cows. Variable costs will

also increase as shown, including and annual change for fertilizer and maintenance costs on the

new 60 hectares of pasture. Income from the grain now being produced on the 60 hectares of

land has no longer received and this reduced income is estimated in ZMW. 140,000 making the

total annual additional costs and reduced income equal ZMW. 176,075.

Additional income will be received from the sale of cull cows, steer calves, and heifer

calves several items are important in estimating this income in addition to carefully estimating

prices and weights.

a) It is unrealistic to assume every cow will wean a calf every year, and this

example assumes 46 calves from the 50 cows.

b) This example assumes herd replacements are raised rather than purchased, so 6

heifer calves must be retained each year to replace the 6 cull cows, which are sold.

This is reflected by only 17 heifer calves being sold each year compared with 23 steer

calves.

The reduced costs include expenses, which will no longer be incurred from planting the

60 hectares of grain no reduction in machinery fixed costs included, as the machinery

complement is assumed to be no different after the proposed change. Labor cost are also

assumed to be unaffected by the change, so no additional or reduced costs for labor are included.

The total additional income and reduced costs are K243, 650 (K133, 400 + 110,250) or +

K67, 575 more than the total additional costs and reduced income, indicating the proposed

change would be profitable.

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Table: Partial Budget for adding 50 beef cows

ADDITIONAL COST ZMW ADDITIONAL REVENUE ZMW

Fixed cost 6 cull cows (300Kg/cow) K10/kg 18,000
Interest on cow herd 12,500 23 steer calves (280Kg/heed/K10/Kg) 64,400
Bull depreciation 1,000 17 heifer calves (200Kg/head/K15/kg) 51,000
Taxes 0

Variable costs

veterinary and health 2,500

Feed and hay 10,000

Hauling 1,000

Miscellaneous 500

Pasture maintenance 7,500

Interest on variable costs 1,075

Total Additional Costs 36,075 Total Additional Revenue 133,400

REDUCED REVENUE REDUCED COSTS

Grain production (40t, 140,000 Fertilizer 60,000
K3,500/t)
Seed 15,000
Chemicals 5,000
Machinery cost 25,000
Interest on variable costs 5,250
Total Reduced Cost 110,250
Total Annual 176,075 Total Annual Additional Revenue And Reduced 243,650
Additional Costs And Costs.
Reduced Revenue
Net change in profit +67,575
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1. Additional Costs

A proposed change may cause additional costs because of a new or expanded

enterprise requiring the purchase of additional inputs.

2. Reduced Revenue/Income

Income may be reduced if the proposed change would eliminate an enterprise, reduce

the size of an enterprise or cause a reduction in yield.

3. Additional Revenue/Income

A proposed change may cause an increase in total farm income if a new enterprise is

being added, if an enterprise is being expanded or if the change will cause yield levels

to increase.

4. Reduced Costs

Costs may be reduced if the change results in elimination of an enterprise, or reduction

in size of an enterprise or some change in technology which decreases the need for

variable resources.

Partial budgeting is intermediate in scope between enterprise budgeting and

whole farm planning. A partial budget contains only those income and expense items

which will change if the proposed modification in the farm plan is implemented. Only

the changes in income are included and not total values. The final result is an estimate

of the increase or decrease in profit.

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3. Complete Budget or Whole farm budget

Definition and description of whole farm budgeting:

A whole farm budget is a summary of the expected income, expenses, and profit for a

given farm plan. It is statement of expected income, expenses, and profit of the firm as

a whole. It considers the costs and returns of operating: the whole farm or particular

crop and livestock enterprises in order to derive the net returns. Complete budgeting is

especially useful for someone planning to enter farming to have an idea of the

profitability of the particular farm enterprise. A farmer who is planning to reorganize

his farm or switch entirely to new forms of farming may find complete budgeting

useful also to estimate net returns or profit. In general, the whole farm budget could be

used to compare alternative plans for profitability, and estimate the operating capital

and total input requirements. It can also be used for further cash flow budgeting and

controlling.

A Complete or whole farm budget is necessary where:

A. the farmer wants to start a new farm, and

B. both the direct costs and the fixed or semi fixed costs are all likely to be

affected.

A complete budget, as the name implies, covers every item of expenditure and income.

In preparing a complete farm budget, the following steps are recommended:

1. Formulation of farm objectives

2. Taking a farm inventory which may include farm buildings, land, land

improvements, e.g. irrigation, breeding stock.

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Uses of whole farm/complete farm budgeting

In addition to providing an estimate of net farm income, a whole farm budget has

several other potential uses.

 It provides a basis for comparing alternative plans for profitability. This can be

particularly useful when planning for growth and expansion.

 The cash expenses in the budget provide an estimate of the operating capital the

business will need during the year.

 Much of the information needed to complete the cash flow budget has

already been gathered and organized in the whole farm budget.

 A detailed whole farm budget showing the estimated profit can be used to help

establish credit and borrow the necessary operating capital.

 The worksheets used to prepare the budget contain estimates of total input

requirements orders for inputs such as fertilizer, seed chemicals, and feed can

be placed using this information.

 The whole farm budget can also be used as part of a system for monitoring and

controlling the business during the year.

The whole farm plan discussed earlier does not provide full and detailed

information on sources and amounts of income, types and amount of expenses and the

total expected profit for the farm business plan. A whole farm budget is needed to

provide additional details and the final estimate of profit. Therefore, a whole farm

budget is a summary of the expected income, expenses and profit for a given farm
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plan. It considers the cost and returns of all the crop and livestock enterprises in order

to derive the net return of the whole farm.

Steps for complete farm budgeting: Basically, it consists of two steps:

1. Preparing a plan that includes the area of each crop, the number of each class of

livestock and the production methods. The proposed plan is based on subjective

judgment, experience and intuition coupled with technical considerations. For example,

an agronomist may have suggested a new crop rotation or a livestock specialist may have

suggested the introduction of a goat enterprise. Thus, several alternative plans may be

prepared.

2. Budgeting the expected costs, including common costs and returns to financially

evaluate each plan and find which one is the best, in terms of expected net farm income.

Table: Whole farm budget showing projected income, expenses and profit

No. Description Amount (ZMW)

1 Income
Cotton 54,000
Milo 43,000
Wheat 13,500
Stocker steers 40,000
Total income 150,000
2 Variable expenses
Fertilizer 11,900
Seed 3,600
Chemical 7,900
Fuel, oil, greases 4,050
Machinery repair 2,650
Feed purchase 1,600
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Feeder livestock purchase 29,000

Custom machine hire 10,250
Operating interest 7,340
Miscellaneous 2,450
Total variable expenses 80,740
Gross margin (1-2) 69,760
3 Fixed expenses
Property taxes 2,600
Interest on debt 22,000
Insurances 1,250
Machinery depreciation 7,200
Building depreciation 3,200
Other fixed costs 3,000
Total fixed expenses 39,250
4 Total expense(2+3) 119,990
5 Net farm income(1-4) 30,510

For a given whole farm budget (Table above), the total farm income is calculated for

each of the enterprises included in the plan. The next step is to estimate the variable costs by

type or category such as seed, fertilizer, and repairs etc. many of these variable costs are the

same as those used to estimate the enterprise budget needed in the planning procedure. The total

cost for each variable input can be found by calculating the total for each enterprise and then

summing across the enterprises.

Notice that some variable cost items such as building repairs, auto and pickup expenses,

utilities, and other farm overhead expenses are very difficult to allocate for specific enterprises

and they are affected little by the final enterprise combination. It these and similar expenses are

not included in the calculation of gross margins of an enterprise budget, they must be included in
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the complete budget. These will make income above total variable expenses of a combination of

enterprises, grater then the total gross margin in the whole farm plan.

The budget in table 4.5 shows an estimated profit or net farm income of the whole farm

if the price and yield estimates are actually realized. Changes in any of these factors will

obviously affect the actual profit received from operating the farm under this plan. The

estimated profit also needs to be carefully interpreted.

Difference of complete budget with other methods

What makes complete budgeting differ from partial budgeting? When the proposed

changes in the farm business are so weeping, they affect the whole farming system and the

technique of complete budgeting is used. However, complete budgeting is not to be divorced

from partial budgeting. These two are mutually complementary, i.e the partial budgeting

technique should be used at various stages of complete budgeting in order to decide the changes

to be effected in the farm organization. In fact, complete budgeting is not to be, and cannot be

disturbed very often, but some changes or improvements have to be made quite frequently where

partial budgeting comes into operations.

Enterprise budget is used to estimate the profitability of a single enterprise while

complete budgeting is for the entire farm, which may consist of several enterprises. Some cost

items that are too difficult to allocate for specific enterprises usually overlooked in the

computation of an enterprise budget that must be included in the whole farm budget.
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Uses of Complete Budgeting

 In addition to providing an estimate of net farm income, a whole farm budget has several

potential uses, such as;

 It provides a basis for comparing alternative plans for profitability. This can be

particularly useful when planning for growth and expansion.

 The cash expenses in the budget provide an estimate of the operating capital the business

will need during the year.

 A detailed whole farm budget showing the estimated profit can be used to help establish

credit and borrow the necessary operating capital.

 The worksheets use to prepare the budget contain estimates of total input requirements.

Orders for inputs such as fertilizer, seed, chemicals and feed can be placed using this

information.

 It is often used in situations where it is realized that the proposed adjustments in the

business will have an impact on several aspects of the business operations because of the

interrelationships that exists between different enterprises.

 It is useful for someone who is planning to enter in to farming business to have an idea

of the profitability of the particular farm enterprise.

 A farmer who is planning to reorganize his farm or switch entirely to new forms of

farming organization may find complete budgeting useful to estimate the net return or

profit of the business.

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4. Cash Flow Budget

It is summary of cash inflows and outflows for a business over a given time period.

Its primary purpose is to estimate the future borrowing needs and loan repayment

capacity of the farm business.

Criticisms of budgeting

It was mentioned that budgeting is one of the most important farm planning tool which

can be used to select the most profitable plan among a number of alternative plans. However, it

also subjected to certain criticisms.

Several criticisms can be made on budgeting of these most of them are equally applied to all

budgeting techniques. One of the techniques is that budgeting assumes a linear relationship

between input and output that virtually ignores diminishing returns and complimentary

relationships between enterprises. If the necessary information is given, however, allowance can

be made for these aspects.