RM 3-10
07-02

Making Decisions with Enterprise Budgets

I. Goals and Objectives

1. Learn what an enterprise budget is and its purpose.
2. Understand how the use of enterprise budgets can help in managing the farm.
3. Learn how to develop an enterprise budget.

1. An enterprise budget is an estimate of the costs and returns associated with the production of some product or products, referred to as an enterprise. An enterprise, sometimes referred to as a profit center, is a distinct part of the farm or ranch business that can be separated out and analyzed as a distinct entity, usually defined based on some production input unit such as an acre of land for most crop enterprise budgets.
2. Projected cost and return estimates contained in enterprise budgets are projections of enterprise costs and returns for some future time period, such as the coming calendar year or crop year. Historical records are a useful starting point for estimating future costs. If you do not have the financial and production records necessary to develop an enterprise budget, you can begin by using budgets from other sources, such as the Extension Service, which can provide information on a regional basis for planning and decision making. If you use this method, you will need to make adjustments to the budget for it to reflect your specific situation.
3. Since enterprise budgets are a part of forward planning, some assumptions are necessary for several areas such as production costs, farm size, equipment needs, production potential, etc.
4. Costs are sometimes broken into two groups referred to as variable and fixed costs, direct and indirect costs, or operating and overhead costs. The variable and fixed classification will be used in this fact sheet.
5. Variable costs are those costs which vary with the size of the enterprise. In the long run, all costs are variable and at a point in time near the end of the production period, almost all costs are fixed. In some cases, it is useful to separate variable costs into pre-harvest and harvest costs.
6. Fixed costs are those costs that the business is committed to pay regardless of the actions taken during the currently defined planning period. Fixed costs include depreciation and insurance on machinery, equipment and buildings; interest on machinery, equipment, buildings and land, and land taxes.
7. In the short run (when at least some costs are fixed), the producer should stay in production if it appears sales revenue will at least cover variable costs. However, if variable costs cannot be covered, continued production, even in the short run, only makes things worse.
8. Enterprise budgets require less data than the whole farm budget, and when realistic and accurate cost allocations can be made by enterprise, the comparative profitability of enterprises can be measured. Enterprise budgets also can be used to derive break-even prices and break-even yields.
9. With regard to allocating costs across enterprises, some costs are easily allocated but for certain indirect (overhead) costs, it is not always clear how the allocation should be made. The key with allocating cost is not to distort relationships so that one would be misguided in choosing between enterprises.
10. Review Table 1 - Example enterprise budget for dryland sorghum.

Income: The gross income section shows the projected value of gross revenue including grain to be sold and possible income from grazing the stalks. Since enterprise budgets are needed before the production period begins, you will be estimating sales prices a year before the products are sold. It is useful to analyze the budget with different combinations of yield and price.

Costs: The second section of the example budget itemizes the variable costs which are divided into pre-harvest and harvest costs. The amounts budgeted for herbicide and fertilizer include the custom application costs. The costs for fuel, lube, repairs and labor reflect what is required for the field operations expected to be performed (land preparation, planting, cultivating, etc.). Interest on operating capital represents an estimate of the amount of interest attributable to this enterprise.

Fixed costs include the depreciation, taxes, insurance and interest on machinery and buildings investment. Each enterprise is allocated a share of the total fixed cost. In the example budget, the operator owns the land and the land cost in the budget reflects typical cash rent for his area.

Returns: Gross income minus variable cost is referred to as returns above variable costs, or gross margin and can be used to compare the profitability of different enterprises in the same business. In the short-run, the producer must at least cover total variable costs or production should be discontinued.

11. If an enterprise budget is being used in conjunction with developing a marketing plan, you could consider how much higher the break-even price would have to be to achieve a price that would also cover a share of family living costs and/or some specified profit margin. For the example sorghum budget, with a yield of 17 cwt. per acre, to provide $20 per acre additional revenue for family living or profit margin, the break-even price would need to be $1.18 more, or $6.55.
12. L. Many farm decisions are related to the profitability of alternative enterprises and how to best utilize available resources. The enterprise budget should be considered only the first step in evaluating an enterprise and eventually developing a marketing plan.

III. Potential Speakers

Extension Economist
Agricultural Lender

What is an enterprise budget?

Answer: An enterprise budget is an estimate of the costs and returns associated with the production of some product or products, referred to as an enterprise. An enterprise, sometimes referred to as a profit center, is a distinct part of the farm or ranch business that can be separated out and analyzed as a distinct entity, usually defined based on some production input unit such as an acre of land for most crop enterprise budgets.

Name some ways an enterprise budget can be used in making management decisions.

Answer: There are numerous uses for enterprise budgets. Some uses are: (1) comparative profitability of enterprises can be measured when realistic and accurate cost allocations are be made by enterprise; (2) identify labor needs, (3) identify how best to utilize equipment, (4) identify amount of capital needed, (5) identify potential areas where you may need to cut costs or modify production practice, (6) identify breakeven price and yield; and (7) identify the level of risk exposure within enterprises.

Jobes, Raleigh, Budgets: Their Use in Farm Management, F-139, Oklahoma Cooperative Extension Service, Division of Agricultural Sciences and Natural Resources, Stillwater, Oklahoma. October, 1994. Available on the Internet: http://agweb.okstate.edu/pearl/agecon/farm/f_139.pdf

Enterprise Budget - an estimate of the costs and returns associated with the production of some product or products, referred to as an enterprise

• Like all forward planning activities, some assumptions are needed
• Production costs
• Farm or ranch size
• Types of enterprises available
• Types of operations and technology involved in production
• Types of machinery and equipment needed
• Soil productivity and yield potential
• Forage quality and quantity
• Operating capital available
• Inventory of machinery, land, and labor

• Fluctuate with:

T the size of the enterprise

T management decisions made (type of tillage operations, etc)

• All costs are variable in the long-run
• May need to distinguish between harvesting costs and pre-harvest costs

• Those costs you are committed to pay regardless of action taken during the planning period
• May already have investments in land, machinery, and buildings
• Includes the depreciation, taxes, insurance and interest on machinery and buildings investment. Each enterprise is allocated a share of the total fixed cost.
• Flexibility of inputs in the long-run (fixed vs. variable)

• Much more difficult to allocate than var. costs
• Some methods to allocate fixed costs:

  T by percentage of acres

  T by percentage of projected gross revenue

  T other

• The key: not to distort relationships so that one would be misguided in choosing between enterprises

• Must cover variable costs in the short-run
• Must cover all costs in the long-run

• Information to use can be your own records, or outside information such as Extension budgets
•  Depends on:

• T Evaluating an existing enterprise

  T Evaluating a new enterprise

   

*Interest cost is based on all pre-harvest costs being borrowed for 6 months.