Partial BudgetingPartial Budgeting

AAE 320AAE 320

Paul D. MitchellPaul D. Mitchell

GoalGoal

1.1. Explain purpose of partial budgetsExplain purpose of partial budgets

2.2. Illustrate their structure and useIllustrate their structure and use

3.3. Give some examplesGive some examples

Partial Budget PurposePartial Budget Purpose Analyze net return from small changes or Analyze net return from small changes or

refinements to farm operationrefinements to farm operation Partial Budget: focus only on parts that Partial Budget: focus only on parts that

change, not budget each enterprise change, not budget each enterprise completely, but build on enterprise budgetscompletely, but build on enterprise budgets

Fine tune current operation: Hold all else Fine tune current operation: Hold all else fixed to evaluate a small changefixed to evaluate a small change

Marginal/incremental analysis: change Marginal/incremental analysis: change input use, shift between inputs or between input use, shift between inputs or between outputsoutputs

Simple ExamplesSimple Examples

Plant rootworm Bt corn or conventional Plant rootworm Bt corn or conventional corn with soil insecticidecorn with soil insecticide

Plant more corn and less soybeansPlant more corn and less soybeans Rent an additional 100 acres for cornRent an additional 100 acres for corn Buy combine or continue custom hiringBuy combine or continue custom hiring Sell current tractor and buy a bigger Sell current tractor and buy a bigger

oneone Soil test for N or just use credits/guessSoil test for N or just use credits/guess

Partial Budget Basic IdeaPartial Budget Basic IdeaBenefits:Benefits: 1) What will be the new or added revenues? 1) What will be the new or added revenues? 2) What costs will be reduced or eliminated?2) What costs will be reduced or eliminated?Costs:Costs: 3) What will be the new or added costs?3) What will be the new or added costs?4) What revenues will be reduced or lost?4) What revenues will be reduced or lost?Partial Budget:Partial Budget: Answer these 4 questions and then calculateAnswer these 4 questions and then calculate

Net Benefit = Benefits – CostsNet Benefit = Benefits – Costs

Partial Budget: Define the change Partial Budget: Define the change analyzedanalyzed

BenefitsBenefits CostsCosts

Additional RevenuesAdditional RevenuesWhat will be the new What will be the new or added revenues?or added revenues?

Additional CostsAdditional CostsWhat will be the new What will be the new or added costs?or added costs?

Costs ReducedCosts ReducedWhat costs will be What costs will be reduced or eliminated?reduced or eliminated?

Revenues ReducedRevenues ReducedWhat revenues will be What revenues will be reduced or lost?reduced or lost?

Total Total BenefitsBenefits

Total CostsTotal Costs

Net BenefitNet Benefit

Planter ExamplePlanter Example Look at buying a planter for 1000 acres of Look at buying a planter for 1000 acres of

corn and soybean versus custom hirecorn and soybean versus custom hire What will be the new or added revenues?What will be the new or added revenues?

Increased yields due to more timely plantingIncreased yields due to more timely planting What costs will be reduced or eliminated?What costs will be reduced or eliminated?

No longer pay for custom plantingNo longer pay for custom planting What will be the new or added costs?What will be the new or added costs?

Fixed and variable costs of owning planterFixed and variable costs of owning planter What revenues will be reduced or lost?What revenues will be reduced or lost?

I can’t think of anyI can’t think of any

Buy planter vs. custom hire for plantingBuy planter vs. custom hire for planting

1000 acres corn-soybeans (500 acres 1000 acres corn-soybeans (500 acres each) each)

Additional RevenuesAdditional RevenuesWhat will be the new or What will be the new or added revenues?added revenues?

Higher yields with Higher yields with more timely plantingmore timely planting

Additional CostsAdditional CostsWhat will be the new or What will be the new or added costs?added costs?

Fixed and variable Fixed and variable costs of owning a costs of owning a planterplanter

Costs ReducedCosts ReducedWhat costs will be reduced What costs will be reduced or eliminated?or eliminated?

No longer pay cost for No longer pay cost for custom hirecustom hire

Revenues ReducedRevenues ReducedWhat revenues will be What revenues will be reduced or lost?reduced or lost?

Can’t think of anyCan’t think of any

Total Total BenefitsBenefits

Total CostsTotal Costs

Net BenefitNet Benefit

Buy planter vs. custom hire for plantingBuy planter vs. custom hire for planting

1000 acres (500 each) corn-soybean1000 acres (500 each) corn-soybean

Additional RevenuesAdditional Revenues3 bu corn x $4.00/bu x 500 ac3 bu corn x $4.00/bu x 500 ac

= = $6,000$6,000

1 bu soybeans x $10/bu x 500 1 bu soybeans x $10/bu x 500 ac ac

= = $5,000$5,000

Additional CostsAdditional Costscorn $19.11/ac x 500 ac corn $19.11/ac x 500 ac

= = $9,555$9,555

soybeans $20.38/ac x 500 acsoybeans $20.38/ac x 500 ac

= = $10,190$10,190

Costs ReducedCosts ReducedCustom corn planting = $15/ac Custom corn planting = $15/ac x 500 ac = x 500 ac = $7,500$7,500

Custom soybean planting = Custom soybean planting = $16/ac x 500 ac = $16/ac x 500 ac = $8,000$8,000

Revenues ReducedRevenues Reduced

nonenone

Total Total BenefitsBenefits

$26,500$26,500 Total CostsTotal Costs $19,745$19,745

Net BenefitNet Benefit $6,755$6,755

Planter ExamplePlanter Example Only focused on costs and revenues that Only focused on costs and revenues that

changechange Made up numbers for illustrationMade up numbers for illustration Estimate 3 more bu of corn and 1 more bu of Estimate 3 more bu of corn and 1 more bu of

soybeans due to more timely plantingsoybeans due to more timely planting Corn = 1% loss/day in WI after May 8Corn = 1% loss/day in WI after May 8 Soybeans: 0.25/bu/day in IA studySoybeans: 0.25/bu/day in IA study

Estimate cost of owning and operating a Estimate cost of owning and operating a planter: Use fast and simple method for 100 planter: Use fast and simple method for 100 acres to get corn = $19.11/ac, soybeans = acres to get corn = $19.11/ac, soybeans = $20.38/ac$20.38/ac

Custom rates: increased WI 2004 rates for Custom rates: increased WI 2004 rates for increased fuel costsincreased fuel costs

Planter Example: What if Planter Example: What if “real”“real”

Look at your records: How late was your Look at your records: How late was your custom planter over the last several years? custom planter over the last several years?

Estimate the average yield loss you sufferedEstimate the average yield loss you suffered Several equations for corn and soybeans on webSeveral equations for corn and soybeans on web

Cost to own and operate planterCost to own and operate planter Used the fast and simple methodUsed the fast and simple method Lower cost if use economic engineeringLower cost if use economic engineering

Is $6,755 ($6.76/ac) enough to justify the Is $6,755 ($6.76/ac) enough to justify the added hassle of owning and operating a added hassle of owning and operating a planter?planter?

Think Break #20Think Break #20

Suppose you are a corn-soybean farmer Suppose you are a corn-soybean farmer who currently custom hires all who currently custom hires all combining. You are thinking of buying a combining. You are thinking of buying a combine. combine.

Do a partial budget analysis of a Do a partial budget analysis of a Combine Purchase vs. Custom Hire Combine Purchase vs. Custom Hire decisiondecision

Needed assumptions/information and Needed assumptions/information and questions are given in the next slidequestions are given in the next slide

Think Break #20Think Break #20Combine Purchase vs. Custom Combine Purchase vs. Custom

HireHire Corn acres = 2,000; Farm crop acres 4,000Corn acres = 2,000; Farm crop acres 4,000 Custom Rate = $25/acCustom Rate = $25/ac Scale Factor = 1.241 + (33.026/acres)Scale Factor = 1.241 + (33.026/acres) 1% yield increase with more timely 1% yield increase with more timely

harvestharvest Average yield = 150 bu/ac; Price = $4/buAverage yield = 150 bu/ac; Price = $4/bu1) What will be the new or added revenues?1) What will be the new or added revenues?2) What costs will be reduced or eliminated?2) What costs will be reduced or eliminated?3) What will be the new or added costs?3) What will be the new or added costs?4) What revenues will be reduced or lost?4) What revenues will be reduced or lost?5) What’s the net benefit?5) What’s the net benefit?

Another ExampleAnother Example

Add 50 beef cows to your cow-calf herdAdd 50 beef cows to your cow-calf herd Convert 100 acres from grain to forageConvert 100 acres from grain to forage

1) What will be the new or added revenues?1) What will be the new or added revenues?

2) What costs will be reduced or eliminated?2) What costs will be reduced or eliminated?

3) What will be the new or added costs?3) What will be the new or added costs?

4) What revenues will be reduced or lost?4) What revenues will be reduced or lost?

5) What’s the net benefit?5) What’s the net benefit?

Revenue BenefitsRevenue Benefits

1) What will be the new or added revenues?1) What will be the new or added revenues? Sell more steers, heifers, and cull cowsSell more steers, heifers, and cull cows

46 calves (92% efficiency)46 calves (92% efficiency) Save 5 heifers as replacements (10% cull rate)Save 5 heifers as replacements (10% cull rate) 23 steer calves: 500 lbs x $0.85/lb = $9,77523 steer calves: 500 lbs x $0.85/lb = $9,775 18 heifer calves: 460 lbs x $0.80/lb = $6,62418 heifer calves: 460 lbs x $0.80/lb = $6,624 5 cull cows $500 each = $2,5005 cull cows $500 each = $2,500

Total = $18,899Total = $18,899

Cost BenefitsCost Benefits

2) What costs will be reduced or 2) What costs will be reduced or eliminated?eliminated?

Variable inputs used for grain productionVariable inputs used for grain production Fertilizer, seed, pesticides, etc.: $5,350Fertilizer, seed, pesticides, etc.: $5,350 Labor: $1,500Labor: $1,500 Variable machinery costs: $1,000Variable machinery costs: $1,000 Interest on variable costs @ 6% = $470Interest on variable costs @ 6% = $470

Total = $8,320Total = $8,320

Cost CostsCost Costs3) What will be the new or added costs?3) What will be the new or added costs? Fixed costsFixed costs

Interest on cows and bulls = $2,500Interest on cows and bulls = $2,500 Bull depreciation = $300Bull depreciation = $300

Variable costsVariable costs Labor = $600, Vet and health = $500Labor = $600, Vet and health = $500 Feed/Hay = $2,000, Pasture fertilizer = Feed/Hay = $2,000, Pasture fertilizer =

$1,500$1,500 Hauling and Miscellaneous = $500Hauling and Miscellaneous = $500 Interest on variable costs @ 6% = $300Interest on variable costs @ 6% = $300

Total = $8,200Total = $8,200

Revenue CostsRevenue Costs

4) What revenues will be reduced or lost?4) What revenues will be reduced or lost? Grain production from 100 acresGrain production from 100 acres

Corn: 110 bu/ac x $2.00/bu x 100 ac = $22,000Corn: 110 bu/ac x $2.00/bu x 100 ac = $22,000 Soybeans: 30 bu/ac x $5.00/bu x 100 ac = Soybeans: 30 bu/ac x $5.00/bu x 100 ac =

$15,000$15,000 Use half of each, since 2 year rotationUse half of each, since 2 year rotation

Total = ½ ($22,000 + $15,000) = $18,500Total = ½ ($22,000 + $15,000) = $18,500

Partial Budget: Add 50 cows to cow-calf Partial Budget: Add 50 cows to cow-calf operation and convert 100 acres to operation and convert 100 acres to forageforage

BenefitsBenefits CostsCosts

Additional RevenuesAdditional Revenues23 Steer calves, 18 heifer 23 Steer calves, 18 heifer calves and 5 cull cows = calves and 5 cull cows = $18,899$18,899

Additional CostsAdditional CostsFixed and variable costs Fixed and variable costs for 50 more cows and for 50 more cows and needed bulls = needed bulls = $8,200$8,200

Costs ReducedCosts ReducedVariable inputs for grain Variable inputs for grain production = production = $8,320$8,320

Revenues ReducedRevenues ReducedRevenue from corn-Revenue from corn-soybean production = soybean production = $18,500$18,500

Total Total BenefitsBenefits

$27,219$27,219 Total CostsTotal Costs $26,700$26,700

Net BenefitNet Benefit $519$519

Comments on AnalysisComments on Analysis

Needed more complete enterprise Needed more complete enterprise budgets for cow-calf and grain budgets for cow-calf and grain operationsoperations

Fixed cost added for cows and bulls, Fixed cost added for cows and bulls, but no fixed cost change for crop but no fixed cost change for crop conversion from grain to forage. Why?conversion from grain to forage. Why?

Labor for cow-calf less than for grain Labor for cow-calf less than for grain ($600 vs. $1,500), an added benefit—($600 vs. $1,500), an added benefit—What will you do with the extra time?What will you do with the extra time?

Comments on Partial Comments on Partial BudgetingBudgeting

Final comments on Partial Final comments on Partial BudgetsBudgets Economies of SizeEconomies of Size Opportunity CostsOpportunity Costs Sensitivity AnalysisSensitivity Analysis Risk ChangesRisk Changes

Economies of SizeEconomies of Size Cause non-proportional changes in cost and revenue when Cause non-proportional changes in cost and revenue when

make changesmake changes Adding 20 cows to herd of 200 will increase labor demand, Adding 20 cows to herd of 200 will increase labor demand,

but less than 10%but less than 10% Dropping 100 acres from 1000 acre grain farm will Dropping 100 acres from 1000 acre grain farm will

decrease costs, but less than 10%decrease costs, but less than 10% Main Point: Linear (proportional) approximation is fine for Main Point: Linear (proportional) approximation is fine for

smallsmall changes, but not for large—need more complete changes, but not for large—need more complete budgeting if large changebudgeting if large change

The concept that the average cost of production per unit The concept that the average cost of production per unit declines as the size of the operation growsdeclines as the size of the operation grows

Result from spreading fixed costs over a large number of units Result from spreading fixed costs over a large number of units of production.of production.

Opportunity CostsOpportunity Costs

Should be included in the analysisShould be included in the analysis Capital needs change: include costs Capital needs change: include costs

(benefits) for borrowing more (less) (benefits) for borrowing more (less) money or tying up more (less) of your money or tying up more (less) of your capital in farm assetscapital in farm assets

Labor and Management changes: Labor and Management changes: include the costs/benefits of your and include the costs/benefits of your and your family's time commitment changesyour family's time commitment changes

Change farm operation due to changes Change farm operation due to changes in credit or labor resources or desiresin credit or labor resources or desires

Sensitivity Analysis Sensitivity Analysis DefinitionDefinition

A technique used to determine how different values of an A technique used to determine how different values of an independent variable will impact a particular dependent independent variable will impact a particular dependent variable under a given set of assumptionsvariable under a given set of assumptions..

very useful when attempting to determine the impact the very useful when attempting to determine the impact the actual outcome of a particular variable will have if it differs actual outcome of a particular variable will have if it differs from what was previously assumedfrom what was previously assumed

can determine how changes in one variable(s) will impact can determine how changes in one variable(s) will impact the target variable. the target variable.

Once an equation, model, or simulation is chosen to Once an equation, model, or simulation is chosen to represent a given system, there is the question regarding represent a given system, there is the question regarding which parts of that equation are the best predictorswhich parts of that equation are the best predictors

Sensitivity analysis involves testing a model with different Sensitivity analysis involves testing a model with different data sets to determine how different data and different data sets to determine how different data and different assumptions affect a model (Porter et. Al., 1980)assumptions affect a model (Porter et. Al., 1980)

Sensitivity AnalysisSensitivity Analysis Assumptions used to construct partial Assumptions used to construct partial

budgets not always known with certaintybudgets not always known with certainty Yield benefit for more timely plantingYield benefit for more timely planting Crop yields and pricesCrop yields and prices Machinery costsMachinery costs

Run analysis with a range of assumptionsRun analysis with a range of assumptions Low, average, high, worst or best case scenarioLow, average, high, worst or best case scenario Find break even price or yield and decide how Find break even price or yield and decide how

likelylikely Formally model the uncertainty: use probability Formally model the uncertainty: use probability

distributions, decision trees, or pay off matrices distributions, decision trees, or pay off matrices and do risk analysisand do risk analysis

Risk and Partial BudgetingRisk and Partial Budgeting Partial Budgeting ignores changes in riskPartial Budgeting ignores changes in risk

Converting 100 acres from grain to forage Converting 100 acres from grain to forage and adding 50 cows to cow-calf operation: and adding 50 cows to cow-calf operation: What are the risk implications? What are the risk implications?

Without formal “tools” comparisons Without formal “tools” comparisons ignore risk, or bring it in afterwards in ignore risk, or bring it in afterwards in ad hoc wayad hoc way ““The financial risk of owning a planter is too The financial risk of owning a planter is too

great to justify the $1,380 net benefit”great to justify the $1,380 net benefit” ““The risk of not finding a custom combiner The risk of not finding a custom combiner

is too great to justify the $6,900 net is too great to justify the $6,900 net benefit”benefit”

More InformationMore Information

Partial Budgeting a common tool in Partial Budgeting a common tool in ag, use Googleag, use Google

Extension Services in many states Extension Services in many states have bulletins or fact sheetshave bulletins or fact sheets U of Maryland (posted)U of Maryland (posted) Penn State (posted)Penn State (posted) Colorado State, Virginia, Vermont, etc. Colorado State, Virginia, Vermont, etc.

SummarySummary Explained and illustrated the purpose of Explained and illustrated the purpose of

partial budgetspartial budgets Did examples, including Think Break #18Did examples, including Think Break #18 Explained some issues/weaknesses of Explained some issues/weaknesses of

partial budgets (size economies, partial budgets (size economies, opportunity costs, sensitivity analysis, opportunity costs, sensitivity analysis, risk)risk)

For problem set and exam: be able to For problem set and exam: be able to make simple partial budget using given make simple partial budget using given information and interpret findingsinformation and interpret findings