' ESQ 1581

Farm Management Principles

I. Factors of Production

The Production Function Historical Perspective What Is Management?

II. Decision-Making

Process Principles

Ill. Decision-Making

Information Techniques

IV. Resource Acquisition

. Size Economics Capital and Credit Buy vs. Lease

V. Resource Use

Enterprise Selection Efficiency

by

Allan E. Lines Department of Agricultural Economics

and. Rural Sociology The Ohio State University

February 1989

I-/

11. FACTORS OF PRODUCTION I

The Production Function

Historical Perspective

What Is Management?

A. The Production Function

1. Mathematical Formulation

v --"'

x --

f --

J-3

2. Graphical Representation

_L -'-f

B. Historical Persoective

1 . Greek Philosophers

a. Aristotle (384-322 B.C.)

b. Prohibition of Usury

c. Religious Perceptions

d.

2. c - ,....h Dh ~·orr "s I ren....,. r 1Y-vl Vii at { 1 ?00's)

a. Industry and Commerce \/Vere Unproductive

b. Land and Land Products Were Only Real \tVealth

c. Prosperity Rested on Freedorr1

d.

I-b

3. Enaiish Political Philosoohers ...,,,... I

( 1 ?00's)

a. Determinants of Prices

b. Concept of Rent

c. ·Prof it Generation

d.

4 I!!. 11 !d· • Philo~!"'\. . lL • l\ll4".,.d x1an Ill ~vpny

(mid- 1800's)

a. Factory System of Drnrlu"+;"n l1 • vV Vi.IV

I o. Exoloitation II

c. Labor Theory of ValL1e

d.

5. Marginal Economists {late 1800's/ early 1900's)

a. Mathematicians

b. Application to Production

c. Marginal Theory of Distribution

ct.

J-g

6. Austrian Economists (turn of century)

a. Factors of Production

b.

c. Produced Factors

7. Current Economics (20th Century)

b.

c. ~Aanageriai Revolution

d.

1 .

2.

Frequently - Heard

a. to

b. ~'Difference Bet'1veen

l\ 'eh sin -1viJ. uUn.,1US Definitions

a. and

b. Combining: Ideas, .- .,.t.. . IV/.§ ~ . I rac111~1es, 1ater1a s,

r: ¥• a

3 U !!" I! - D f. ...!!.. .. . •seru1 ;-arm em 1n1 t~On

I-))

•••

II - 1

II. DECISION-MAKING

Process

Principles

II - 2

A. The Decision-fvlaking Procsss

1. What ~Jtakes a Farmer SuccessfLJI?

a. ~Aechanical Abiiity?

b. Anronom·1~t? ~· I BBB ~'&I •

c. ·Animal Scientist?

d. ~/Janagerial Ability?

2. Managerial Decisions

a. Production

'1Vhy? ¥/hat?

II - 3

b. Acquisition'--~ how much? hovv? v1hen? where?

II - 4

3. Decision - iV1akino 1liii#

a. Set Goals

h hi. Recoanition

"""'

c ii I "" " . n .... ~i.l"m;-o,i;ji on fi '1tJ1gi ~tli g Iii ,, Iii V .. II .~... I,,

I n -·

f. Action

g. Responsibility

h • IS Decision

II - 5

B. Fundamental Economic Prine oles

1 . Production Concepts

a. Fixed and Variable Factors

b. Diminishing Returns

1 ) Added Output f ram Added lnout Decreases •

2) Results from Fixed Factors

~ 1' G 111?". a. · o-. 1 ........ ~c R d. • • ;:; ~ ; ~ ~! epresen Lat1on

II - 6

c. Factor Substitution

1) C b. 1• om -1nat1ons nu---i--1 •t ~ ~:a I I ~-i!! ~ - - .. ~-

--·n R ,. a th ....

3) if'"' !I •

\:lrapn1c Representation

d. Product Combinations

1 ) Same Factors Can Produce Different Products

II - 7

2) Competing Factor Use

3) Graphic Representation

C . J. OSL

a. Cash/t'1on - Cash

b.

1) n)· ~

\.

1 J

Out ... of - poci<et Opportunity Depreciation

and

II - 8

2) Total, A·verage, rv1arginal

II - 9

::t. RC-i'10nue C-on, ..... Pnt· s ...... .;;,., !;f '"""~ !I !...! ."'J ~t-1 -

a. Total

b. Marginal

a. rv1arginal Revenue Iii

arginal Cost

b~ Equal i\t1arginal Revenues

c. Least - Cost Combination of Factors

d. ~Aost Profitable Co.mbination of Cutouts

I

III-!

Ill. DECISION-MAKING

Information

Techniques

III-2

1 . Accounting

a. Information Generation

1)

2)

b. Permits

Understanding 1) 2) 3)

Application o·f Principles Perforrnance and

Analysis 4) Fin~n,...i~• ~+~+t:lm~n+s

;; "'......,. 11vn • ..;i.5 v'l.C!.11o'lol1 1%#1 1111

Ca Necessary for Problem Solvina -

and ~Aeasures

a. Isolate Strengths and eaknesses

h.. L;m:~1.n.~lt'°' e"'t..,....t fi..2 j ' \ii:+;;'~.;.::) \:) t;'

c. Useful Set for Higi1 Priority Problems

1) 2) n\

·0}

4) 5) 6)

d. Use Several Factors

III-3

e. Focus on Impact Factors

- -· __j I If" ~ • 0. ::stanaaras ror Gompar1son

a. Comparison Necessary

1) Good/Bad 2) !l ,. i /L M1Qt1 0'-11

b. Objectives \!Viii

1) 2)

d~ Sources

1) 2) 3)

3) 4)

Var'/ ..

III-4

III-5

•

1 . Budgeting: Testing Alternatives

a. Ans\1ver 3 Questions

1)

2)

3)

b. Types of Budgets

1) Partial

2) Total Farm

~\ r'a(!h Flovv v/ v '"\.#f I

4) E11terprise

et

1 . Test Affected Part of Business

2. Outiine

III-6

D. Investment Analvsis · ,,._

1 . Time Value of ~v1oney

a)

b)

c)

2. Comcoundina . -

3. Discounting

III-7

III-8

4. Net Present Value

a. Steos II

1) Investment to Analyze

2) Initial Cash Outlay

~) 0 Annual f\Jet Cash Flovvs

4) Discount Rate

5) NP V's

6) Decide

b. Method

Item Years

Cash Fiov'V NP'J

0

c. Issues

.1) 2) 3) 4) 5) 6) 7)

III-9

d. lnteroretation •

2) Compare Only = Planning Periods

3) Compare Only = Size Projects

4) l~ssumption

5) Financial Feasibiiity

III-10

IV-1

IV. RESOURCE ACQUISITION

Size Economics

Capital and Credit

Buy vs. Lease

A. ize Economics

1 . Size Change

a. b. c. d.

2. General Cost - Size n ........ 11'"'!!•; 0 n. !L .. · nt: dlilt n;:;nn:>

Ii

IV-2

IV-3

3. Tecl1nical Economies of Size

a. Only Affect Costs

b. Cost Per $ Gross Income

Corn R IJ. Grain -t-a '"'rr' s uei:jt. . ! !. !

Farm Farm Farm Farm~

A B c D

:cropland 77 141 272 Total Cost

·Average .66 .62 .59 .51 <;:

il• .. .. - '

IV-4

4 P . r- • £.i'""r,• . -nee c:conom 1es o 1 ~1ze

a. Input Price Discounts

Discounts by Farm Size, Ohio Acres

100-179 260-499 1 ooo+ I % Discount • • • • • • I ·Seed 2.4 4.3 10.8 I

F~-.'!.p;-A"" U il,j~ I -· I J&.;-• 2.2 2.8 6,... -.v I

- ChAmica1~ 1.4 2.2 7.8 I "' I - I ·1'1;,t

- ~Aachinery 1.3 3.8 7Q I .....

b. Product Price Premiums

IV-5

5. Managerial Economies of Size

a. Labor Management

b. Overall ~llanaoement -

B.

IV-6

r!,;io=t- -""I ""nd CrQdi+ \...I~'.'.' I Clm Ga ; '\;# 1 -.

1. HovJ tv1uch Capital?

a. Equate Marginal Return ·+h . \ft/I \.• ii I

b R !I !" I• . ,,e1at1onsn1p

2. Al!ocation of Capital

a. Principal: Equimarginai Returns

b. Budgeting and NPV •

IV-7

3. Atcquisition ~;1ethods

a. Owner Equity

b. Debt

c. () J. • I

\Ju~s1ae r- .. caun:v

• ...

d. Lease/Rent

u r, " !I c ... 4. • .ovv 1V1ucn red1t

a. ~v1ax : Borrovving· Capacity

b. l\Jiaintain Credit Reserve

c. Profit/Risic/Capacity

5. Leverage

Total Assets Debt

f- Net Vvorth Leverage

IV-8

B

L r,. - -t:Veraae -

I (\f ~Ja \l\forth • ~vl n ..... ~ ... ~= --'-1!' "'""' u l -&1 A~s(,::J. +CJ. - 101.81 ~ y _'1/1,p'l~

to A I Cost ~

nf V11

ROR to N\l\j

and Profit

Leveraoe

0.0

IV-9

4 ~ I .U

IL

IV-10

7. Leverage and Risk

· t'1et Worth ·Debt

·. Total Assets

ROA ; R to A . Cost of Debt

(12%) · R to ~~\f\J

. ROR to NVv

Leveraae Ratio

0.0 1.0

-"'-

IV-11

Capacity

a. Loan Lenqth and -& AH

Repayment Capacity $1,000 P\vailable

Repayment ~ Years

1 -b

10 20

interest 1 #5\0fi u-o

$ 909 -"'7Qi v:v

6145 R r 1 LJ1 oO t

• I

Rate 14o/o

$ 877 •

~A:i~ v """t' '- v

5216 6623

.,,_ F'

IV-12

b. Estimating Repayment Capacit;l

t"et Farm Income

+ nenretr:i-~ion --r" -v~d.b 1

+ Interest Paid - Family Living .... Income Tax - r.11rr~nt I n~n Paym~nts

........ \di I-· I I. "'"""11¥"\.AI I 1-1 I I.

- Down Payments + Non-Farm Income + Gi.=+s e"'lr""" . I l· 1 L\.I.

0 Repayrnent Capacity

60,000

+20,000 +15,000 -20,000 -10,000 -40.000 •

- 5,000 + 3,000 + 0

if 17,000

C.

IV-13

uv vs. Lease ;;;,

1. Land

a. Which To Do?

1 ) Preference to Ovvn 2) Preferred Loan Security 3) \IVindfaH Gains/Losses 4)

\

5J c\ U/

7) 8) 9)

10)

F• •m ·~9 • 1ex101uty

Expansion

Changing Economy Land Security Living Conditions Financial Situation

IV-14

b. Purchasing

1) Max Bid: Profitability -

2) Max Bid: Feasibility

3) Risk

4 .. ) Q,,vnership Cost

c. Lease

1 ) Local Custom

2)

3 \ p ll'l•ll !! 1! ' §;IOO""'',.aoil~ J ii ! llL h,....

4) tv1arket

5) Con!ls - ~t-

IV-15

IV-16

2. Machinery

a. Purchase

I ) Ownership

DH:lTI ~ h ; I ""'1i

2) Operating Costs

3) Total Cost Per fl.~cre

IV-17

b. Lease

1) Control V\/ithout 0'1vning

2) t\lot V\iidelv Used ""

~\ 'f;;J I

f\.lnt I ~V'L

Cl&:intina I &vii l! ~Ill i~

4) Use Situations

-....

-....

c. Use r~PV to Decide

l t~m • ~. I

PV k"PV

Item

Lease Income Tax After Tax CF Discount F. PV "-JPV

Purchase

0

50,000 0

50,000 1.0

Lease

0

11 ,500

10,000 i .0

Vo.~r :;-:-~s:..--

.; • '

n u -7,280 -7,280 .9091

YA$4r fl~~ ......

1 •

11 ,500 -3,700 7,800 .9091

IV-18

-:""; . . ...,..

0 -3i 192 -3, 192 .6209

£:: . • . v

5,000 -3 7nn

' """" "" 1 ,300 .6209

V-1

V. Resource Use

Enterprise Selection

Efficiency

V-2

1 . Determinants of p 2 •• roauct1on

a. Physical

Climate Topography C.nil~ \..JViiiw

Biology

b. - . t:conom1c

Comparative Advantage r. .t."t" vOmpet.I .. Ive Advantage

c. Process

n I t• L. LOCa1on

a. What Have Farmers Decided?

1\ ,.., 1....1 } il\1nr 1"1

lf IJ' VI 'l!oA

2) U.S.

3) Ohio

V-.3

V-4

v-s

L

V-6

V-7

3. Comparative Advantage

a. Principle

';fvheat Corn Ratio

"Produce That Product VVhere Your Production Advantage Is Greatest or Your Disadvantage Is Least"

• Illustration 0.

Illinois Ka-oas , _. i h.;;u -

(bu) so 30 120 60 ?4 -· 2.0

..

c. Sources

A. • •

a. Princiole •

"Produce That Has Lowest

b. Illustration

c. Source

V-8

Product Vvhich Opportunity Cost"

V-9

5m Enterprise Combination

a. Common Sense

1 ) Identify Resources

2) Enterprise Examination

3) Choose fv1ost Profitable

5) Add .. Others

V-10

b. Linear Proarammina - -1) c 1er"'1 -0 n•s L...i i i\.ri " of Solution

Enterprise Choices

Reauirements •

Limits

Per ll~cre

V-11

2. Graohicai Presentation ii

Corn

Soybeans

V-12

1 . Definition

2. Inputs

3. Outputs

' \

4. Principles

a. Fixed Inputs

Overhead Cost Per I ini+ '-'I I\

Units Produced

b. Variable Inputs

1) f\Jot ~Jlcaximum Output Per Unit

V-13

·· 2) ~Aarginal Cost • tJJarginal Revenue

_N • I Cost .MQ. :-LrJ "'4}:{ i\ii ,, l~'~l I 1V~. ,

30 ~ ~ 6.00 40.0

40 8.00 41.0 50 10.00 41.5 60 12.00 41.75