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 Title Page
 Introduction
 Example 1: A reduction in fertilizer...
 Example 2: Changing to a new...
 Example 3: Purchasing a combin...
 Summary
 References
 Author






Group Title: Florida Cooperative Extension Service circular 837
Title: Analyzing changes in the farm business
CITATION PAGE IMAGE ZOOMABLE PAGE TEXT
Full Citation
STANDARD VIEW MARC VIEW
Permanent Link: http://ufdc.ufl.edu/UF00049229/00001
 Material Information
Title: Analyzing changes in the farm business partial budgeting
Series Title: Circular Florida Cooperative Extension Service
Physical Description: 5 p. : ; 23 cm.
Language: English
Creator: Ford, S. A ( Stephen Allyn )
Publisher: Florida Cooperative Extension Service, Institute of Food and Agricultural Sciences, University of Florida
Place of Publication: Gainesville
Publication Date: 1989
 Subjects
Subject: Farm management   ( lcsh )
Genre: government publication (state, provincial, terriorial, dependent)   ( marcgt )
bibliography   ( marcgt )
non-fiction   ( marcgt )
 Notes
Bibliography: Includes bibliographical references (p. 5).
Statement of Responsibility: Steve Ford.
General Note: Cover title.
Funding: Florida Historical Agriculture and Rural Life
 Record Information
Bibliographic ID: UF00049229
Volume ID: VID00001
Source Institution: Marston Science Library, George A. Smathers Libraries, University of Florida
Holding Location: Florida Agricultural Experiment Station, Florida Cooperative Extension Service, Florida Department of Agriculture and Consumer Services, and the Engineering and Industrial Experiment Station; Institute for Food and Agricultural Services (IFAS), University of Florida
Rights Management: All rights reserved, Board of Trustees of the University of Florida
Resource Identifier: oclc - 20742500

Table of Contents
    Copyright
        Copyright
    Title Page
        Page i
    Introduction
        Page 1
    Example 1: A reduction in fertilizer use
        Page 2
    Example 2: Changing to a new enterprise
        Page 2
    Example 3: Purchasing a combine
        Page 3
        Page 4
    Summary
        Page 5
    References
        Page 5
    Author
        Page 6
        Page 7
Full Text





HISTORIC NOTE


The publications in this collection do
not reflect current scientific knowledge
or recommendations. These texts
represent the historic publishing
record of the Institute for Food and
Agricultural Sciences and should be
used only to trace the historic work of
the Institute and its staff. Current IFAS
research may be found on the
Electronic Data Information Source
(EDIS)

site maintained by the Florida
Cooperative Extension Service.






Copyright 2005, Board of Trustees, University
of Florida





Circular 837


Analyzing Changes in
the Farm Business:
Partial Budgeting


Steve Ford


/


Central Science
Library
NOV 201989 i
I"'!ersity of Floridd









Introduction


Farmers constantly consider adjustments to
their farming practices as input prices, output
prices, and technology change. Farmers search for
ways to increase profits through considering alter-
native methods and strategies of production. Par-
tial budgeting is a simple analytical technique that
can be used to analyze small and moderate changes
to the farm production process.
Partial budgeting can be used to analyze the
profitability of proposed changes in the farm busi-
ness. Partial budgeting suggests an organized way
of thinking about how any change in the farm oper-
ation will affect farm profits. Its usefulness, how-
ever, lies in its simplicity. Only factors that are di-
rectly affected by the proposed change are included
in the partial budgeting analysis. Although further
analysis of any change would be necessary to ana-
lyze effects of the change on the entire farm's fi-
nancial situation (whole farm analysis), partial
budgeting determines immediately whether an al-
ternative might add to the overall profitability of
the farm. Partial budgeting can be used, then, to
weed out changes that are clearly unprofitable be-
fore undertaking more complex whole farm analy-
sis.
Partial budgeting can be especially useful when
analyzing particular types of changes in the farm
business. The changes include:
substituting a new enterprise for part or all of
an existing enterprise;
substituting one input for another;
increasing or decreasing the level of input use;
increasing or decreasing the size or scale of an
enterprise; and,
purchasing a machine or some other asset.
The format for creating a partial budget is pre-
sented in Figure 1. The benefits from a change in


Figure 1. Partial budgeting format.
Column A Column B

Added Costs Reduced Costs
Reduced Income Added Income
Total (Column A) Total (Column B)

Change in Profitability (B-A) _


the farm business are weighed against the costs in-
curred by the change. The costs in column A of
Figure 1 consist of the added costs that will be in-
curred by the change and the reduced income that
will result from the change. The benefits in column
B are the opposite of the costs. Benefits include re-
duced costs of production and increased income. If
total benefits are greater than total costs, then the
proposed change will be more profitable than the
existing situation. The opposite is true if the costs
are larger than the benefits.
Partial budgeting depends on accurate cost and
income information. Calculating accurate cost and
income information requires accurate price and
quantity estimates. Prices and quantities are
usually not known with certainty. Estimates can
be made more accurately, however, with careful
attention to detail and with good research on the
problem at hand. Yield estimates can be obtained
from historic farm records and university extension
and research publications. Prices are more difficult
to estimate although market news services, USDA
outlook estimates, and futures markets all give
indications of coming price trends.
It can be seen from the format presented in
Figure 1 that increased profits from the farm
business are possible under the following situa-
tions, where a change in the farm business results
in:
added income and reduced costs,
added income that is greater than added costs,
added income that is greater than reduced
income with no change in costs,
reduced costs that are greater than reduced
income, and
reduced costs that are greater than added
costs.
Several other combinations of reduced and added
income and costs are possible. However, the partial
budgeting analysis will always provide a correct
assessment of the change in profitability for an
alternative.
The following three examples illustrate uses of
partial budgeting. A change in fertilizer use, a
decision to switch to a new enterprise, and a
decision to purchase a combine are analyzed using
partial budgeting. The concepts of break-even
prices and quantities, and when to include fixed
costs in partial budgeting analysis are also dis-
cussed.









Example 1: A Reduction in
Fertilizer Use
A farmer is considering alternative methods of
reducing corn production costs. The farmer has
been advised that a reduction in nitrogen use
might be one way to cut production costs. Univer-
sity research suggests that a 40-pound reduction in
nitrogen will result in an estimated yield reduction
of only four bushels per acre. The price of nitrogen
is $0.22 per pound and corn is selling at $2.50 per
bushel.
The problem involves both a reduction in costs
and a reduction in income. There are no added
costs, but applying nitrogen at a lower rate reduces
costs by $8.80. There is a $10.00 reduction in in-
come associated with the four-bushel-yield change,
but there is no increased income.
The reduction in income is greater than the
reduction in costs (Figure 2), so the change in the


nitrogen application rate would be inadvisable.
The market price for corn, however, will generally
be uncertain. The change might be advisable with
a lower corn price. The information in the partial
budget allows the calculation of the maximum corn
price that would make this a profitable strategy. In
Figure 2, a reduction in corn price of $0.30 per
bushel (-$1.20 + 4 bu.) to $2.20 per bushel makes
the alternative just as profitable as the current
nitrogen application rate. The break-even price of
corn in the analysis, then, is $2.20 per bushel.
Only the parts of the farm business that are
affected by the change are included in the analysis.
The other variable and fixed costs of corn produc-
tion are not necessary to the analysis because they
do not change with a reduction in nitrogen use in
this example.


Figure 2. The decision to reduce fertilizer use (per acre).
Column A Column B

Added Costs Reduced Costs
none 40 lbs. N @ $0.22 = $8.80
Reduced Income Added Income
4 bu. @ $2.50 = $10.00 none
Total (Column A) $10.00 Total (Column B) $ 8.80

Change in Profitability (B-A) -$1.20


Example 2: Changing to a
New Enterprise
The analysis of substituting one enterprise for
another involves entries in each of the four cate-
gories in the partial budget: added costs, reduced
income, reduced costs, and added income. As one
enterprise is taken out of production, both its costs
and income are reduced (to zero). As a new enter-
prise is brought into production, new, added costs
are incurred and added income is realized. Again,
only the factors of production that change with the
new enterprise are included in the analysis. For
example, there will be no land charge included
since the same land is used in each enterprise.


The example given here involves a farmer who
wants to grow fifty acres of staked tomatoes on
land that had formerly been used to grow irrigated
field corn. Most of the irrigation equipment will be
used for the tomatoes, however some new equip-
ment must be purchased. Much of the land prepara-
tion machinery and tractors will continue to be
used on the tomatoes as well. However, some new
machinery must be purchased for the tomato
enterprise. Fixed costs of the added machinery
must be included in the analysis if incurred solely
because of the change being considered. Machinery









Example 1: A Reduction in
Fertilizer Use
A farmer is considering alternative methods of
reducing corn production costs. The farmer has
been advised that a reduction in nitrogen use
might be one way to cut production costs. Univer-
sity research suggests that a 40-pound reduction in
nitrogen will result in an estimated yield reduction
of only four bushels per acre. The price of nitrogen
is $0.22 per pound and corn is selling at $2.50 per
bushel.
The problem involves both a reduction in costs
and a reduction in income. There are no added
costs, but applying nitrogen at a lower rate reduces
costs by $8.80. There is a $10.00 reduction in in-
come associated with the four-bushel-yield change,
but there is no increased income.
The reduction in income is greater than the
reduction in costs (Figure 2), so the change in the


nitrogen application rate would be inadvisable.
The market price for corn, however, will generally
be uncertain. The change might be advisable with
a lower corn price. The information in the partial
budget allows the calculation of the maximum corn
price that would make this a profitable strategy. In
Figure 2, a reduction in corn price of $0.30 per
bushel (-$1.20 + 4 bu.) to $2.20 per bushel makes
the alternative just as profitable as the current
nitrogen application rate. The break-even price of
corn in the analysis, then, is $2.20 per bushel.
Only the parts of the farm business that are
affected by the change are included in the analysis.
The other variable and fixed costs of corn produc-
tion are not necessary to the analysis because they
do not change with a reduction in nitrogen use in
this example.


Figure 2. The decision to reduce fertilizer use (per acre).
Column A Column B

Added Costs Reduced Costs
none 40 lbs. N @ $0.22 = $8.80
Reduced Income Added Income
4 bu. @ $2.50 = $10.00 none
Total (Column A) $10.00 Total (Column B) $ 8.80

Change in Profitability (B-A) -$1.20


Example 2: Changing to a
New Enterprise
The analysis of substituting one enterprise for
another involves entries in each of the four cate-
gories in the partial budget: added costs, reduced
income, reduced costs, and added income. As one
enterprise is taken out of production, both its costs
and income are reduced (to zero). As a new enter-
prise is brought into production, new, added costs
are incurred and added income is realized. Again,
only the factors of production that change with the
new enterprise are included in the analysis. For
example, there will be no land charge included
since the same land is used in each enterprise.


The example given here involves a farmer who
wants to grow fifty acres of staked tomatoes on
land that had formerly been used to grow irrigated
field corn. Most of the irrigation equipment will be
used for the tomatoes, however some new equip-
ment must be purchased. Much of the land prepara-
tion machinery and tractors will continue to be
used on the tomatoes as well. However, some new
machinery must be purchased for the tomato
enterprise. Fixed costs of the added machinery
must be included in the analysis if incurred solely
because of the change being considered. Machinery









that is already used on the farm is not included,
since the annual fixed charges for that machinery
will continue to be incurred regardless of the
change.
The added costs in the analysis are for tomato
production. Total variable pre-harvest costs are
estimated to be $2,480 per acre, harvest and
marketing costs are estimated to be $4,610 per
acre, and the annual fixed costs of added machinery
and irrigation equipment are estimated to be
$5,500 per year. Total added costs for fifty acres are
$360,000 (Figure 3).
Reduced income from the removal of irrigated


Figure 3. The decision to switch enterprises (50 acres).
Column A


Added Costs
Tomatoes:
Total variable pre-
harvest costs
Harvest and mar-
keting costs
Fixed costs
Total
Reduced Income


Corn:
130 bu. x $2.50 x
50 acres = $ 16,250
Total (Column A)


$124,000

$230,500
$ 5,500


$360,000


$376,250


corn is calculated to be $325 per acre. The total
costs of switching to tomato production sum to
$376,250 for fifty acres.
Reduced costs from the discontinued corn
production amount to $260 per acre for a total of
$13,000. Added income from tomato sales is
estimated to be 1200 cartons per acre at $7.00 per
carton, or $8,400 per acre. This results in total
benefits to the enterprise change of $433,000 and a
net change of $56,750. The change to tomato
production appears to be a profitable alternative to
the continuation of corn production given the costs
and returns used in the analysis.


Column B


Reduced Costs
Corn:
$260 x 50 acres =







Added Income
Tomatoes:
1200 cartons x $7 x
50 acres =
Total (Column B)


$13,000


$420,000


$433,000


Change in Profitability (B-A) $56,750


Example 3: Purchasing a Combine
The final example of partial budgeting presented
here concerns the decision to purchase a combine
rather than to continue custom hiring the opera-
tion. A farmer currently grows 250 acres of soy-
beans. Combining is now custom hired for $22 per
acre. The farmer provides the wagons and hauling.
A new combine will have total annual fixed costs of
$8,085 and variable costs of $4.68 per acre. Fixed
costs are included in the analysis of the combine


purchase since they are incurred only if the
combine is purchased.
The added costs of owning and operating the
combine are $9,255 for 250 acres. The reduced cost
of having to custom hire the combining is $5,500.
In this case the added costs are greater than the
reduced costs with no change in income (Figure 4).
The combine purchase would be unprofitable.









Figure 4. The decision to purchase a soybean combine (250 acres).


onltnmmn A


Column B


Fixed Costs
Variable Costs
($4.68 x 250 acres)
luced Income
none
Total (Column A)


$ 8,085
$ 1,170


$ 9,255


Reduced Costs


Custom Hire =
($22 x 250 acres)


Added Income
none
Total (Column B)


Additional information can be obtained from this
analysis, however.
An important point to note is the maximum
amount that the farmer would be willing to pay for
custom combining. The total cost per acre of
owning and operating a combine (for 250 acres) is
$37.02 per acre. It can be calculated either by
dividing the total costs of owning and operating
the combine by 250 acres, or by dividing the net
profit by 250 acres ($3755 / 250 = $15.02) and
adding it to the custom hire rate ($22 + $15.02 =
$37.02). The farmer would not be willing to pay
more than this amount for custom combining,
since ownership of the combine would be cheaper
than higher custom rates.


Figure 5. The decision to purchase a soybean combine
Column A


Added Costs


Fixed Costs
Variable Costs
($4.68 x 250 acres)
luced Income
none



Total (Column A)


$ 8,085
$ 1,170


$ 9,255


The farmer might also consider hiring out
custom combining in order to justify purchasing a
combine. The number of acres necessary to custom
combine to make this a sound investment can be
calculated. The current net loss of this change in
the farm business is $3,755. Assuming that the
farmer can also charge $22 per acre for custom
work and will have variable costs of $4.68 per acre,
$17.32 can be applied toward added income in this
analysis for every acre that is custom combined.
The farmer will need to custom combine 217 acres
($3,755 + $17.32) in addition to the home farm to
justify the purchase of the combine (Figure 5).




and do custom work.
Column B


Reduced Costs
Custom Hire =
($22 x 250 acres)

Added Income


Custom Hire =
($17.32 x 217 acres)
Total (Column B)


$ 5,500


$ 3,758


$ 9,258


Change in Profitability (B-A) $3


Added Costs


Rec


$ 5,500


$ 5,500


Change in Profitability (B-A) -$ 3,755


Rec


Pnluimn A Column B-









Partial budgeting only attempts to analyze the
economic profitability of a change in the farm busi-
ness at the enterprise level. Whole farm analysis of
changes may also be necessary. For example, in the
combine purchase analysis, there may be added tax
benefits arising from the combine purchase. There
may also be increased labor constraints at harvest
due to the increase in labor requirements when
combining is no longer custom hired. These effects
are best analyzed at the whole farm level.

Summary
Partial budgeting is a simple, accurate tool for
the analysis of small-to-medium-sized changes in
the farm business. It requires that only factors
affected by the proposed change be included in the
analysis. Further, once the net profitability of a
proposed change is known, it is relatively easy to


calculate break-even prices above or below which
the proposed change may be profitable. The valid-
ity of the analysis depends on the accuracy of the
cost and income information being used. Yet, par-
tial budgeting is a powerful tool that every farmer
should employ in the analysis of alternatives to cur-
rent farming practices.

References
Boehlje, M. D. and V. R. Eidman. Farm Manage-
ment. John Wiley & Sons, New York. 1984.
Castle, E. N., M. H. Becker, and A. G. Nelson.
Farm Business Management, third edition.
Macmillan Publishing Company, New York. 1987.
Kay, R. D. Farm Management: Planning,
Control, and Implementation, second edition.
McGraw Hill Book Company, New York. 1986.









Partial budgeting only attempts to analyze the
economic profitability of a change in the farm busi-
ness at the enterprise level. Whole farm analysis of
changes may also be necessary. For example, in the
combine purchase analysis, there may be added tax
benefits arising from the combine purchase. There
may also be increased labor constraints at harvest
due to the increase in labor requirements when
combining is no longer custom hired. These effects
are best analyzed at the whole farm level.

Summary
Partial budgeting is a simple, accurate tool for
the analysis of small-to-medium-sized changes in
the farm business. It requires that only factors
affected by the proposed change be included in the
analysis. Further, once the net profitability of a
proposed change is known, it is relatively easy to


calculate break-even prices above or below which
the proposed change may be profitable. The valid-
ity of the analysis depends on the accuracy of the
cost and income information being used. Yet, par-
tial budgeting is a powerful tool that every farmer
should employ in the analysis of alternatives to cur-
rent farming practices.

References
Boehlje, M. D. and V. R. Eidman. Farm Manage-
ment. John Wiley & Sons, New York. 1984.
Castle, E. N., M. H. Becker, and A. G. Nelson.
Farm Business Management, third edition.
Macmillan Publishing Company, New York. 1987.
Kay, R. D. Farm Management: Planning,
Control, and Implementation, second edition.
McGraw Hill Book Company, New York. 1986.





































































* Steve Ford is an Assistant Professor Extension Farm Management Specialist, Department of Food and
Resource Economics, Institute of Food and Agricultural Sciences, University of Florida, Gainesville, FL










































































This publication was produced at a cost of $595.60, or 30.0 cents per copy, to provide information on analyzing
changes in the farm business. 7-2M-89


COOPERATIVE EXTENSION SERVICE, UNIVERSITY OF FLORIDA, INSTITUTE OF FOOD AND AGRICULTURAL SCIENCES, G.L.
Zachariah, director, in cooperation with the United States Department of Agriculture, publishes this information to further the purpose of the
May 8 and June 30, 1914 Acts of Congress; and is authorized to provide research, educational information and other services only to
individuals and institutions that function without regard to race, color, sex, age, handicap or national origin. Single copies of extension
publications (excluding 4-H and youth publications) are available free to Florida residents from county extension offices. Information on bulk
rates or copies for out-of-state purchasers is available from C.M. Hinton, Publications Distribution Center, IFAS Building 664, University of
Florida, Gainesville, Florida 32611. Before publicizing this publication, editors should contact this address to determine availability. ... ...




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