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Budgeting for better decision-making this year

Sarah Cornelisse for Progressive Forage Published on 27 December 2018
Bedgeting for a better year

Decision-making in a farm business is a daily occurrence. Some of these decisions can significantly impact the profitability of your farm business.

Having a budget available to look at when faced with certain decisions can improve your ability to benefit, not harm – or cause the least possible financial harm – to your farm business.

A budget is a plan looking at the money you expect to receive and what you expect to spend. There are several types of budgets: whole-farm budget, enterprise budget, partial budget and cash-flow budget. This article will discuss enterprise budgets.

Enterprise budgets serve as the building blocks for a whole-farm budget and as the foundation for analyzing possible changes within an enterprise through partial budget analysis. A well-constructed enterprise budget will allow you to assess the profit potential of a given enterprise.

Developing accurate budgets

Developing a solid enterprise budget is not difficult, though if you are just starting your farm operation or have not maintained good records of past income and expenses, your task will be more time-consuming, as more research will be required.

Step 1. Identify your enterprise

Take a look at your farm and what you are growing or producing. When choosing what constitutes an enterprise, you have some flexibility. For example, some dairy farmers may group all crops grown into one enterprise – crops. Others will single out each crop grown (corn, hay, soybeans, etc.) as its own individual enterprise and construct a budget for each.

If you’re concerned about the profitability of a crop on a field-level basis, you could construct your enterprise budgets in that manner as well (ex. Corn – field No. 1, Corn – field No. 2, etc.). While developing budgets for each individual crop may require more time, when it comes to analyzing and using those budgets, you will be better equipped to quickly make a decision you can feel confident in knowing the impact of it.

Step 2. Collect all income and expense receipts

If you’ve been in business but haven’t yet constructed a budget, or perhaps it’s been a while since you’ve made a budget, budgets can be constructed using your farm records. Gather all income and expense receipts you have on hand. Accuracy of the numbers in a budget is crucial, and basing projections for the coming year off multiple previous years’ data is preferable to using just a single year’s data. However, start with what you have available.

If you don’t have any historical financial information to use in the construction of new budgets, you may find completing steps 2 and 3 at the same time to be useful. The major difference being, instead of using historical data to guide you in making your projections for the coming year, you’ll be researching input and yield quantities and current prices you either expect to pay or receive.

Step 3. Categorize income and expenses

The enterprise budget has two sections – income and expenses. Expenses are then further broken down into variable and fixed expenses, also referred to as operating and ownership expenses. Variable expenses, or operating expenses, are those expenses you incur as a result of performing your farming activities. Examples of variable expenses include fuel, oil, hourly employee pay, etc.

Fixed expenses, also called ownership expenses, will include insurance, depreciation and other expenses that don’t change as a result of the amount of work performed or crops grown.

Some fixed expenses may need to be allocated to several enterprises. In most situations, your allocation is going to be an educated guess unless you keep very detailed records on the use of items (buildings, machinery, etc.).

Step 4. Construct your budget and analyze

Your last step is putting your information into the correct enterprise budget format and then analyzing the resulting budget. In Table 1 is the standard format for an enterprise budget.

Enterprise budget format

All revenue items for the enterprise are grouped together at the top and then total revenues calculated. Below that are the expenses (costs), grouped into variable and fixed. Costs are totaled and then subtracted from total revenues to calculate expected net income for the enterprise.

You’ll notice, rather than just listing a total expense or revenue number for each budget item, enterprise budgets typically include information on the unit type for each item, number of item units used or sold and the cost per unit. This level of detail serves a purpose. If the revenue or expense total for a particular item varies drastically from year to year, or is consistently out of normal range, you have a starting point for further investigation.

For instance, if total fertilizer expense is high, why is that? Are proper application rates being followed, is soil quality an issue, etc.? You’ll then be in a better position to decide how to handle the issue.

In addition to net income, enterprise budgets are also used for break-even analysis. You can either determine your break-even price or break-even yield. Calculation of breakevens will give you either the minimum price per unit or minimum yield required to cover all expected costs.

How often should you update or revise your budgets?

While it is recommended enterprise budgets be updated at least annually, they can be updated as often as you feel it is needed. In times of price volatility, you may decide to revise your budget more often, perhaps when a significant price change occurs or if you make a significant change to your production practices that impact variable expenses. Typically, when revising budgets, you likely will only need to update a few numbers.

Creating and revising budgets doesn’t require sophisticated software, but you may find using a spreadsheet program or other application can simplify the creation and revision processes.

Accurate and up-to-date budgets will serve you well in the management of your farm business. They serve as an important source of financial information in decision-making. By evaluating the efficiency of your farm’s enterprises on a regular basis, you can capitalize on profitable enterprises and more quickly identify and fix poorly performing aspects of your farm business.  end mark

PHOTO: Getty Images

Sarah Cornelisse
  • Sarah Cornelisse

  • Sr. Extension Associate
  • Dept. of Agricultural Economics, Sociology and Education
  • Penn State University
  • Email Sarah Cornelisse