Budget AnalysisAg 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

Planning a budget

4 Factors of Budget Production

Capital Labor Land Management Must know the amount and value of each

7 Questions Managers Must Answer

1. What are available factors of production?2. What is the best way to use available factors?3. What crop and/or livestock enterprises are

possible?4. What proportion of the land should be used for

each crop or livestock activity considered?5. What labor is necessary?6. What capital is needed?7. What management and production practices

should be used?

What is Budgeting?

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 Budgeting1. Helps you plan for the useful life of assets2. An excellent device for organizing3. Useful to estimate the amount of credit needed

from lending agencies4. Allows for experimentation with possible

outcomes before resources are actually committed

5. Identifies cost and income items that might be otherwise overlooked

6. 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

1. Decide what you want to analyze with the budget

2. Decide whether to use enterprise or partial budgeting

3. Choose a time period for the budget. (Month, quarter or year)

4. Decide what data will be needed.5. Decide how many alternatives will be

evaluated or analyzed.

5 Steps to Develop a Budget

1. Appraise the business and family goals and objectives

2. Inventory resources available for use in the farm or ranch operation.

› Inventory should consider the available levels of land, labor, capital and management.

3. Select the physical data for inputs and outputs4. Select the market prices for inputs and outputs5. Calculate the expected cost and returns.

Enterprise Budget

Enterprise Read p.4-4 to 4-10

Partial Budgeting

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

Negative

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

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

7 Componenets of a Partial Budget

Column One Column TwoNegative Effects Positive Effects

1. Additonal Cost 4. Additional Returns

2. Reduced Returns 5. Reduced Costs

3. Total Additional Costs and Reduced Returns

6. Total Additional Returns and Reduced Costs

7. Net Change in Income (Line 6 minus Line 3)

Cash Flow Budgeting

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--