Whether on the tractor, in the barn, or at the farm office, farm managers are always mulling over some change to their operation that might improve profitability. It might be employing a new technology, launching a new enterprise, buying or leasing machinery, altering a production practice, or some other possible change.
Occasionally, one of those ideas takes hold and the farm manager puts pencil to paper—or fingers to keyboard—to determine if the change is really a good idea. The primary question is: How will the change impact profitability? However, there are other questions too, such as: What are the risks? What about non-economic factors like family time?
Partial budgeting is an analytical tool for determining answers to the first question about impact on profitability. It is also a method for analyzing operational changes—renting versus owning, raising your own replacements versus using a custom heifer raiser, employing a new technology versus keeping an old one, etc.
- What will the increased revenues be?
- What will the eliminated or reduced costs be?
- What will the increased costs be?
- What will the eliminated or reduced revenues be?
A farm manager should first answer these four questions to determine the impact of the change on profitability. Note that the first two questions identify increases to profitability and the last two questions identify decreases to profitability. After answering these questions, the farm manager should compare the net change. If it is positive, then the change may be warranted.
Before beginning a partial budgeting analysis, the farm manager must be clear about their objectives, especially as regards profitability. Are they primarily concerned with increasing cash flow or do they have wider economic objectives? Once a farm manager has a clear idea about their objectives, a potential change can be analyzed in one of two ways: either through a cash-profitability analysis or an economic analysis, explained below.
If it is a cash-profitability analysis, then non-cash items like depreciation, unpaid labor and management, and opportunity costs need not be considered when analyzing the change.
If it is an economic analysis, then non-cash items must also be considered. Not including depreciation, unpaid labor and management, or opportunity costs that are tied up in the change could result in a decision that increases cash flow, but that is not truly profitable or that is not as profitable as some alternative.
A truism about any planning/budgeting analysis is that the results are only as good as the accuracy of the cost and revenue estimates used. Farm managers can consult several sources to determine a reasonable range of prices, production costs, hours, labor needs, repair costs, rental rates, etc. Sources may include the history of their own operation, the experience of others, market data, and university and industry research and experimental results. Consulting these sources will help identify the more volatile estimates and thus where sensitivity should be included in the overall analysis.
Conducting a partial budgeting analysis
The Extension Partial Budget Tool consists of Excel worksheets that provide a means by which to conduct a partial budget analysis. The Partial Budge Tool consists of a main tab or worksheet, the “Partial Budget Worksheet,” and additional tabs that support the development of the partial budget.
Download the Explanation of Extension Partial Budget Tool instructional document for a short description of how to use the tool.
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- Download the Extension Partial Budget Tool.
- Clearly identify the change to be made (row 2, “Description of the change.”)
- Answer the four questions across row 4 by inputting detail into rows 6–21, as needed.
- Review the net impact on profitability amount (row 24, “Estimated Net Financial Impact If the Change Is Made.”)
- Finally, consider any risks and non-economic impacts, such as impact on family time, etc.
Also included in the Partial Budget Tool is a worksheet for estimating the annual cost of capital assets. Information needed for this worksheet includes acquisition cost of the capital asset, salvage value, useful life, and an estimate of the percent of average value for repairs, insurance, and other costs. These are formula estimates that might not track your actual costs well, but they are a benchmark and a place to start.