by Linda Burbidge
Originally published by Dakota Farmer at farmprogress.com
Farm businesses operate in a dynamic environment where uncertainties and risks are inherent. In navigating these challenges, employing effective financial management tools is crucial. Partial budgeting analysis stands out as a powerful technique for farm businesses to assess and optimize changes in their operation that apply across the entire farm plan.
By focusing on the incremental changes resulting from a specific decision, partial budgeting offers several notable benefits.
Partial budgeting provides a structured framework for evaluating the financial implications of specific management decisions on a farm. Some specific questions you might use partial budgeting to answer would be whether adopting a new technology is feasible, altering crop rotations, adjusting input usage, increasing herd size, or hiring custom harvesting.
How to use this analysis
Farmers can use partial budgeting to weigh the costs and benefits, so they can effectively compare the change in profitability based on the change they are considering in the operation. This allows for informed decision-making tailored to the unique circumstances of the farm, leading to more strategic and efficient resource allocation.
Moreover, partial budgeting aids in identifying potential sources of cost savings and revenue enhancement. By analyzing the incremental changes in costs and returns associated with a decision, farmers can pinpoint areas where adjustments can be made to improve profitability.
Whether it involves reducing input costs, increasing yields or diversifying revenue streams, partial budgeting helps uncover opportunities for optimization within the farm operation.
Real-life example
Consider a farm that is looking at adding an extra 50 beef cows to their operation, and in doing so, would need to rent 450 more acres of pasture ground and convert 100 acres from grain to feed. To do a partial budget, a farmer would need to identify four things:
- additional costs
- reduced revenue
- additional revenue
- reduced costs
Nos. 1 and 2 take away from profitability and represent the cost of the change. Nos. 3 and 4 will add to profitability and represent income from the change. These are often set up in a column to compare the costs and benefits.
Based on the above example, additional costs would be:
- pasture rent
- interest on the loan for the additional cattle
- additional production costs for cattle and feed
- depreciation of the breeding livestock
Note that the entire cost of the new breeding livestock is not included because that becomes an investment and shows up on the balance sheet, but interest and depreciation would be included.
Reduced revenues would be the grain sales given up in an average year. Additional revenues would be the sales of additional steer and heifer calves, and the sale of additional cull cattle. Finally, reduced costs would be reduction in grain production costs. The example is also presented below.
In addition, partial budgeting enhances risk management capabilities for farm businesses. Partial budgeting allows farmers to simulate various scenarios and evaluate their resilience to potential risks, enabling them to make proactive decisions to mitigate adverse market, weather or production outcomes. In our example, we could look at the impact under high, low and average calf prices to see the difference in the outcomes.
Another major benefit of partial budgeting is its ability to facilitate long-term planning and investment decisions. By quantifying the financial implications of different options, farmers can assess the viability of capital investments, such as buying new equipment or expanding operations.
Partial budgeting enables them to compare the expected returns and payback periods associated with various investment alternatives, guiding them toward investments that align with their strategic goals and financial capabilities.
Partial budgeting provides a systematic framework for evaluating the incremental impacts of management decisions. This can help farmers make informed choices, identify opportunities for improvement, manage risks effectively and plan for the future with confidence.
Burbidge is a farm management instructor at Dakota College at Bottineau. The North Dakota Farm Management Education Program provides lifelong learning opportunities in economic and financial management for those in farming and ranching. Visit ndfarmmanagement.com.
Original Article: https://www.farmprogress.com/farm-business/how-to-maximize-farm-profitability