Partial budgeting: Analyzing changes on your farm
As a farm operator, how do you decide whether or not to try a new crop or variety, new herbicide, piece of equipment/technology, or a new cultural practice?
As a farm operator, how do you decide whether or not to try a new crop or variety, new herbicide, piece of equipment/technology, or a new cultural practice? Do you do it because your neighbor does it, or because it feels right?
Just because your neighbor bought a new combine does not mean it is profitable for your operation. With the volatility of crop and livestock prices—not to mention input costs—it probably makes sense to analyze the decision in an organized logical method. To do this you should use a framework to look at the trade-offs of the decision. A partial budget is a simple useful financial tool to evaluate changes you may make on your farm.
It analyzes net financial return from small changes or refinements to your farm operation. It focuses only on those income and expenses that change with the proposed new alternative. Basically you consider the benefits and costs of the proposed change by answering four questions.
On the benefit side, you ask:
1. What will be the new or added revenues
2. What costs will be reduced or eliminated?
On the cost side, you ask:
3. What will be the new or added costs
4. What revenues will be reduced or lost?
Then calculate the net benefit or income by subtracting the costs from benefits. To download a useful partial budget spreadsheet to assist you with your lists and calculation can be found at: https://www.msu.edu/user/betz/financialmgt/index.htm
For example, you could use a partial budget to consider alternative enterprises such as growing 100 acres of corn instead of 100 acres of dry beans. If you already have the equipment to produce and harvest either crop then you only need to consider those costs and revenues that change. Looking at the benefit side of the equation if you expect corn to yield 150 bushels per acre and you anticipate selling it for $6.50 per bushel then 100 acres would give you an additional $97,500. If the total costs to grow dry beans are $550 per acre then by not growing 100 acres would reduce costs by $55,000. The total additional revenue and reduced costs is $152,500.
On the cost side, the reduced revenue from not growing dry beans would be the anticipated yield of 22 hundredweight per acre times the expected price of $40.00 per hundredweight times 100 acres for a total reduced revenue of $88,000. In addition you have the cost of growing corn. If the total costs to grow corn are $690 per acre then it would cost $69,000 to grow the 100 acres of corn. The total reduced revenue and additional costs is $157,000.
In this simple example the change in net income would be $152,000 minus $157,000 for a negative $4,500. Therefore it would not be financially beneficial to switch from dry beans to corn.
This partial budget just looked at the financial picture. One also needs to consider various production and financial risk; factors such as timeliness of operations like planting and harvest, how it fits into a crop rotation, labor availability, etc.
Partial budgeting has its limitations. It is useful for measuring short term simple changes. If the change involves longer term changes or purchases then tools like capital budgeting may be more appropriate. These tools take into account the time value of money that partial budgets may not. Labor and management changes may need to be considered. Partial budgeting does not always consider risks involved in the change such as the availability of markets or legal risks.
When doing partial budgeting is a good idea to run the analysis with a range of costs, yields and prices to get a sense on how these may affect your net result.