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 Budgeting

1. Helps you plan for the useful life of assets

2. An excellent device for organizing

3. Useful to estimate the amount of credit needed from lending agencies

4. 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 outputs

4. Select the market prices for inputs and outputs

5. 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

Eff

ects

of C

han

ges

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 Two

Negative 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--