Using Enterprise Budgets in Farm Financial Planning

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3 Using Enterprise Budget Information Careful analysis of a budget before investing in an enterprise familiarizes the potential producer with inputs and their prices, production and management practices involved in production, and possible income. It also provides an-depth study of the components such as yields and market prices builds awareness of the risk involved in production. An old saying goes, If you can t pencil a profit, you aren t likely to plow one. A well-developed enterprise budget can demonstrate a good understanding of the business aspects of an enterprise to a lender and enhance prospects for funding. Knowing the potential returns to an enterprise allows a producer to make informed rental offers for land or machinery. As the margin between income and expenses on agricultural enterprises is often narrow, offering too much for land rents can result in losses to the enterprise. Estimating the net returns (income minus variable and fixed costs, excluding the land charge) for the production activity sets the upper limit on what can be paid for land. The landlord and tenant then negotiate a rate that is fair to both parties. The wheat enterprise budget (Figure 2) provides information on breakeven grain prices and yields in a summary table at the bottom of the budget sheet. Breakeven analysis is a useful technique in weighing revenue relative to costs. Revenue per acre is determined by price multiplied by yield, then adding any other income. To calculate a breakeven figure, hold one revenue component constant (either price or yield) and solve for the other component so that enterprise revenues equal costs. For example, the breakeven price above operating input costs using an expected yield of bushels per acre is \$2.89 per bushel. This amount is determined by using the following formula: (P BE x Yield) + Other Income = Operating Cost P BE x Yield = Operating Cost - Other Income P BE = Operating Cost - Other Income Yield Subtracting other income (here, zero) from total operating costs (\$96.01), then dividing by the production level of bushels provides the breakeven price. To determine the breakeven yield to cover operating inputs in comparable fashion, the formula is: (\$5.25/bu. x Y BE ) + \$0/a = \$96.01/a \$5.25/bu. x Y BE = \$96.01/a \$96.01/a Y BE = \$5.25/bu. Y BE = 18.3 bu./a Similar calculations may be made to reveal grain breakevens covering total costs (also shown in the breakeven summary table). Enterprise budgets also provide historical or projected data necessary to build whole farm plans and conduct financial analysis. The enterprise budgets are summed and added to any overhead costs not included in the enterprise budgets to derive total farm costs and returns. Specific questions such as how and what to produce, production levels, and achieving goals can be addressed. While calculations may be done by hand, software makes summary and analysis, as well as evaluation of alternative scenarios, much easier. Summary and Conclusions Enterprise budgets are designed to provide a decision framework for short- and long-range economic analyses of production agriculture. Enterprise budgets assist in understanding the costs and returns of a production activity, identifying potential sources of risk, and evaluating alternatives. Knowledge of budgeting and the ability to use them helps producers make sound business decisions. 1 Contact your Area Agricultural Economics Specialist or the OSU Agricultural Economics Department, 515 Agricultural Hall, Stillwater, OK 74078, (405) for more information on IFFS. AGEC

5 Figure 1 Comments Cull Sales Income Treatment Cull sales income for breeding livestock is treated as recommended by the American Agricultural Economics Association (AAEA) Task Force. The treatment of income depends on whether the breeding herd is from raised or purchased sources. The net income shown on an enterprise budget to analyze profitability may be less than total cash sales. Sale price times the number of head determines receipts from raised livestock since the cost of raising them is included as enterprise operating costs. For purchased animals, only the amount of sales exceeding salvage value is included in income. The cost of the purchased animal is prorated over its life through depreciation and the cull animals are presumed to be at the end of the useful lives, thus fully depreciated. This convention prevents an economic double counting of culled income. In the budget example, half of the total cull cows were assumed to be from purchased and half from raised sources. In addition, raised replacement heifers were sold and bull sales were from purchased sources. As illustrated in the production section, cull cow income includes total cash receipts from six raised animals plus the sales amount above salvage value on six purchased animals. For replacement heifers, total income is equal to total cash receipts since all were originally raised for breeding purposes. Finally, total cull income for one purchased bull is equal to the sales price per head less salvage value as it is assumed to be at the end of its useful life (fully depreciated). Reference AAEA Task Force. Commodity Cost and Returns Estimation Handbook. February AGEC-243-5

6 Figure 2. Dryland Wheat Enterprise Budget- Grain Only (sample only) See for information on OSU Enterprise Budget Software. Garfield County- North Central OK Owner-Operator, owned equipment 1000 acres farmed, 160 acres for this budget Continuous no till Extension Total PRODUCTION Units Price Quantity \$/Acre Wheat Bu. \$ \$ Small Grain Pasture Acre Other Income Acre \$ \$ Total Reciepts \$ OPERATING INPUTS Units Price Quantity \$/Acre Wheat Seed Bu./Acre \$ \$ 8.26 Fertilizer Acre \$ \$ Custom Harvest Acre Pesticide Acre \$ \$ Crop Insurance Acre \$ \$ 2.10 Annual Operating Capital Dollars 7.25% \$ 1.94 Machinery Labor Hrs \$ \$ 3.72 Custom Hire Acre Machinery, Fuel, Lube, Repairs Acre \$ \$ Other Expense Acre Total Operating Costs \$ Returns Above Total Operating Costs \$ FIXED COSTS Units Rate \$/Acre Machinery/Irrigation \$/Value Interest at Dollars 7.50% \$ 3.88 Taxes at Dollars 1.00% \$.81 Insurance Dollars 0.60% \$.31 Depreciation Dollars \$ 5.76 Land \$/Acre \$ 800 Interest at Dollars 3.00% Taxes at Dollars 0.43% 3.44 Total Fixed Costs \$ Total Costs (Operating + Fixed): \$ Returns Above All Specified Costs \$ (5.85) Grain Break Even (B-E) Analysis B-E Yield at \$/bu B-E Price at bu./acre Above Operating Costs 23 Above Operating Costs \$2.27 Above Total Costs 35 Above Total Costs \$3.43 Break-even yield is the yield needed to cover costs given the expected price, pasture income, and and other income, such as government payments. Break-even price is the price needed to cover costs given the expected yield, pasture income, and other income. AGEC-243-6

7 The Oklahoma Cooperative Extension Service Bringing the University to You! The Cooperative Extension Service is the largest, most successful informal educational organization in the world. It is a nationwide system funded and guided by a partnership of federal, state, and local governments that delivers information to help people help themselves through the land-grant university system. Extension carries out programs in the broad categories of agriculture, natural resources and environment; family and consumer sciences; 4-H and other youth; and community resource development. Extension staff members live and work among the people they serve to help stimulate and educate Americans to plan ahead and cope with their problems. Some characteristics of the Cooperative Extension system are: The federal, state, and local governments cooperatively share in its financial support and program direction. It is administered by the land-grant university as designated by the state legislature through an Extension director. Extension programs are nonpolitical, objective, and research-based information. It provides practical, problem-oriented education for people of all ages. It is designated to take the knowledge of the university to those persons who do not or cannot participate in the formal classroom instruction of the university. It utilizes research from university, government, and other sources to help people make their own decisions. More than a million volunteers help multiply the impact of the Extension professional staff. It dispenses no funds to the public. It is not a regulatory agency, but it does inform people of regulations and of their options in meeting them. Local programs are developed and carried out in full recognition of national problems and goals. The Extension staff educates people through personal contacts, meetings, demonstrations, and the mass media. Extension has the built-in flexibility to adjust its programs and subject matter to meet new needs. Activities shift from year to year as citizen groups and Extension workers close to the problems advise changes. Oklahoma State University, in compliance with Title VI and VII of the Civil Rights Act of 1964, Executive Order as amended, Title IX of the Education Amendments of 1972, Americans with Disabilities Act of 1990, and other federal laws and regulations, does not discriminate on the basis of race, color, national origin, gender, age, religion, disability, or status as a veteran in any of its policies, practices, or procedures. This includes but is not limited to admissions, employment, financial aid, and educational services. Issued in furtherance of Cooperative Extension work, acts of May 8 and June 30, 1914, in cooperation with the U.S. Department of Agriculture, Robert E. Whitson, Director of Cooperative Extension Service, Oklahoma State University, Stillwater, Oklahoma. This publication is printed and issued by Oklahoma State University as authorized by the Vice President, Dean, and Director of the Division of Agricultural Sciences and Natural Resources and has been prepared and distributed at a cost of 42 cents per copy Revised GH. AGEC-243-7

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