Profitability Using Budgets
Budgets are the first step in any profitability analysis. The basic idea is easy: Revenue minus Cost. The devil is in the details: predicting prices received, quantities produced, and full costs. Three broad types of budgets each answer different questions:
- Enterprise budgets answer, "What will be my net earnings from this activity?"
- Partial budgets answer, "How would my net earnings change if I substitute a different enterprise or way of doing things?"
- Break-even budgets answer, "What would be the lowest price or yield I must receive in order to break even?"
Enterprise budgets and single-enterprise break-even budgets show profitability when they indicate a positive net income. But sometimes a manager is already earning a positive return from an enterprise that would be replaced by the one under examination. For that case, partial budgets and comparative breakeven analysis for changing enterprises are more informative.
- Using Enterprise Budgets in Farm Financial Planning: This Oklahoma State University bulletin explains each section of an enterprise budget, with examples for crop and livestock enterprise budgets.
- Interactive Enterprise Budgets: See examples at bottom of page.
- Partial Budgeting: A Tool to Analyze Farm Change: This Iowa State University site explains partial budgets in detail, using an example of a change from raising to buying replacement heifers for a dairy farm.
- Using A Partial Budget: This University of Wyoming site shows how partial budgeting can be used to analyze a decision on whether to buy a piece of depreciable equipment. Although the tax and interest rates are not current, the example illustrates a quick approach to an equipment replacement decision.
- Single enterprise break-even analysis can answer the questions: “How many units would I have to sell in order to cover my costs?” “What sales revenue would I need to cover my costs?” “What price would I have to charge to cover my costs?”
- Break-Even Point: The U.S. Small Business Administration offers an online calculator to find the output level where revenues cover both fixed and variable costs, if you know the selling price.
- Break-even price: The FarmLogs page “Know Your Costs” illustrates how to calculate the price that will cover your costs, if you know the output level (a crop yield, in this case).
- Comparative Break-even Analysis for Changing Enterprises: The basic method for break-even analysis in single enterprises can be extended to look at changing enterprises. The key is to add the “opportunity cost” of net returns that would be foregone in giving up the old enterprise to the variable costs of the new enterprise. A Michigan State University Extension bulletin explains the approach with application to comparing alternative crops.
Sample Agricultural Enterprise Budgets:
- Enterprise Budgets: Michigan State University Extension offers a variety of downloadable enterprise budget spreadsheets for field crops, nursery crops, and livestock.
- Budgets for Horticultural and Livestock Production: Penn State Extension’s “Ag Alternatives” site offers links to fact sheets that contain sample enterprise budgets for a variety of fruit, vegetable, field crop, and livestock enterprises.
- Online Budgets for Field Crops and Vegetables: University of Wisconsin Extension’s enterprise budget site can be used to navigate to detailed budgets for dairy and vegetables, as well as field crops and livestock.