Professional Documents
Culture Documents
1.0 Introduction
Budget is defined as an estimate of future incomes and expenditure. It is a numerical plan to
quantify the numerical and financial effects of a proposed plan.
Farm budgets include gross margin budget, whole farm budget, partial budget, break even budget
and cash flow budget. These budgets should be done before the onset of the production
cycle/season of any enterprise. These assist management on ascertaining on which enterprise to
select and the scale at which to operate.
Unit 1
1.0 The Gross Margin Budget
This is a single enterprise budget showing the enterprise gross income, total variable costs and
the gross income. An enterprise could be a livestock or crop under taking. Common examples
include maize, beef, wheat and broilers.
1.1Objectives of the Unit
By the end of this unit you should be able to:
These costs are directly related to the level of production. The costs can be directly allocated to a
specific enterprise for instance cost of maize seed, fertilizers, and dipping costs for the dairy
enterprise. There is a linear relationship between output and variable costs as shown below in
fig 1.
Costs
Size of enterprise
Fig. 1 Variable Cost Against Output
1.2.4
These costs are unresponsive to changes in the size of enterprise. They are not directly allocable
to an individual enterprise. Fixed costs are unavoidable even if you do not produce. Fig. 2 below
shows the graphical relationship between output and fixed costs.
Costs
Fixed cost curve
Enterprise Size
Fig. 2 Fixed Costs against Enterprise Size
Fixed cost curve does not start at zero because fixed costs are incurred always. These costs
include rent, rates, bank charges, electricity, interest on loans, accounting fees, permanent labour,
depreciation
1.2.5 Gross Margin (GM)
The difference between gross income and total variable costs of an enterprise is referred to as
gross margin.
Gross margin = gross income (GI)- total variable costs(TVC)
GM
1.2.6
= GI- TVC
This is a livestock enterprise budget. It shows livestock trading profit, total variable cost and the
gross margin for the livestock enterprise.
1.2.7
The financial value assigned to a class of animals. This value does not change from year to year.
2
1.2.8
The ratio compares gross income to total variable costs of the enterprise.
1.2.9
iii.
iv.
v.
vi.
Estimating and specifying input requirements. For this consider the recommended
input quantities or use records for past seasons.
Estimating the quantity of the output by considering the expected yield for the
enterprise. Past records are useful for this exercise. The farm can also consider
nation averages and records of neighbouring farms.
Estimating prices of inputs and output by considering the current prices and an
allowance for the inflation rate.
Calculating gross income by multiplying total output with price per unit. Variable
costs are calculated by multiplying individual quantities by their price per unit and
the sum up to obtain total variable costs.
Comparing costs and returns by deducting total variable costs from gross income
to obtain gross margin.
Identify the most limiting factor and calculate returns to the factor. If land is
limiting factor consider gross margin per hectare. If capital is the limiting factor
consider return per dollar of variable costs. This helps in enterprise selection.
15
Expected yield
Expected price
$300
Gross income
$ 19350
Variable Costs
Item
Labour
Tractor operating
Seed
Fertilizer
Chemicals
Packaging
Transport
Other
Total variable costs
units
Labour days
Litres
Kg
Kg
litres
bags
bags
Quantity
2040
450
375
4500
20
1290
1290
4% of VC
Total costs
5712
2250
750
2250
260
774
1935
145
14076
3
Gross margin
= Gross income
Total variable costs
= $19350
$14076
= 1.37
= Gross margin
Number of hectares
= $5274
15ha
= $351.6/ha
Comments on the gross margin: the enterprise is viable because it has a positive gross margin.
Return per dollar of 1.38 shows that gross income covers variable costs because it is greater than
one. The gross margin per hectare of $351.6 shows the gross return for a hectare of the
enterprise.
1.5
Stock
01/10/09
2
48
2
purchases
births
slaughters
+12
+13
stock
30/09/10
2
47
13
12
20
20
30
40
174
5
5
-
52
52
+20
+15
+15
+ 40
25
20
15
40
49
211
10
115
deaths
-13
-12
-20
20
-30
-40
115
20
3
3
1.5.2 The livestock trading account for the beef herd for year ending 30 September 2010
number
FSV
number FSV
Total value
2
48
2
12
20
20
30
40
174
500
300
250
260
240
250
180
100
1 000
14 400
500
3 120
4 800
5 000
5 400
4 000
38 220
2
47
13
25
20
15
40
49
211
1 000
14 100
3 250
6 500
4 800
3 750
7 200
4 900
45 500
5
5
10
52
236
Purchases
Bullying heifers
heifers
1750
1500
3250
Births
calves
Trading profit 11 530
53 000
Hides sales
Bulls
Cows
Cull cows
Bullying heifers
heifers
Steers
weaners
Calves
20
2
22
3
Total
236
500
300
250
260
240
250
180
100
Sales
Steers
Slaughters
Cull cows
7 000
500
7 500
Deaths
calves
53 000
$40
Variable costs
Labour
$500
Tractor operating
$100
Feeds
$1200
Drugs
$50
Veterinary charges
$ 25
Transport
$ 150
Other
$50
Total variable
$2075
= Gross income
Total variable costs
= $11570
$2075
= 5.58
Calving percentage
Mortality rate
= number of births
X 100%
Cows + bulled heifers
= 52
X 100%
= 86.7%
= number of deaths
Average herd size
X 100%
3 X
100%
(174+211)/2
= 1.6%
1.6 Limitations of gross margin analysis
Can not effectively assess enterprises which utilize different types of land if land is
the limiting factor for example sheep production and potato production.
Does not consider other factors which are not monetary like managerial skills and
social factors for example workers morale.
Requirements for fixed costs differ per enterprise for example buildings, machinery
but gross margin does not cover this. Such costs cannot be allocated to individual
enterprises
Assumes a straight line relationship ignoring diminishing marginal returns to the
input factor.
It fails to capture changes in the environment for example low rainfall, in availability
of inputs and changes in government policies.
1.7 Uses of the gross margin technique
The budget enables management to determine structure of farm business determined by the
enterprise mix.
An assessment of viability of each enterprise can be done. The enterprises are ranked according
to profitability and the most ideal ones are selected.
The whole farm gross margin is used to calculate the net farm profit. The information is required
for planning purposes in future.
6
UNIT 2
2.0 Total Farm Budgets
In farming the total budget is the whole farm budget which comprises a financial analysis for the
whole farm business. This budget estimates the integrated income from all enterprises; all
expected expenditure which includes variable costs, fixed costs and drawings by the farm owner.
The whole farm budget covers the whole farming year starting from the first of October to the
30th of September of the following year. The budget shows the net farm income and farm surplus
which shows business potential for growth.
2.1 Objectives of the Unit
After reading this unit you should be in a position to:
labour, machinery, irrigation facilities, and market demand and impose market quotas. The
farmer should also consider his managerial skills and personal preferences.
iv) Workout the gross margin budgets for the targeted enterprises. Assuming that land is the most
limiting factor, budgets could be worked out on per hectare basis for comparison. Depending on
the farm situation, other limiting factors can be identified. If that is the case, produce gross
margin budgets based on the most limiting factor such as return per variable expenditure.
Determine the maximum possible enterprise sizes depending on the most limiting constraints.
v) Select the best performing enterprises on the basis of profitability and maximum possible sizes
allowed by constraints. Some advanced techniques such as linear programming can be employed
to come up with the ideal enterprise mix.
vi) Assess the level of fixed costs such as depreciation, interest payments, farm insurance, rent,
telephone charges and managerial salaries. Fixed costs are required for the calculation of net
farm income. The net farm income is the difference between the whole farm gross margin and
the fixed costs.
vii) Estimate the farms commitments and personal expenditure requirements such as holiday
allowances, living expenses, school fees and taxes. Personal expenditure items are referred to as
drawings. These are required for the calculation of farm surplus. The farm surplus is calculated
as net farm income less drawings.
viii) In view of the calculated farm surplus, future capital development plan can be developed.
Examples of capital developments are acquiring fixed assets and constructing water supplies.
Plans can also be made to expand profitable enterprises and to introduce new and promising
enterprises.
2.5 Methods of Farm Profitability
Farm profitability can be improved using the following methods discussed below:
i) Reduction of fixed costs. In the long run fixed costs can be reduced by acquiring efficient
equipment such as modern tractors.
ii) Increasing out put by adopting new techniques of producing such as use of recently
discovered hybrids.
iii) Reducing input cost by the use of recommended input quantities. Substitute machinery for
labour. Acquire inputs at competitive prices.
Maize
15ha
4.3t/ha
$300/t
19350
Sorghum
8 ha
4.8t/ha
$280/t
10752
Beef
193 heads
5712
2250
750
2250
260
774
3504
1466
570
1059
162
325
500
100
1935
145
14076
Gross income
19350
Gross margin
5274
Return per$ VC
1.37
Whole farm gross margin
Maize
Sorghum
Beef
Less fixed costs
Rent
Farm insurance
Electricity
Depreciation
Interest charges
Net farm income
Less drawings
Taxes
Living expenses
Holiday expenses
Loan redemption
Farm surplus
5274
2611
9495
768
106
1564
186
27
140
1200
700
500
11530
733
244
8141
1200
50
25
150
50
2075
10752
2611
1.32
11530
9495
5.56
17380
2651
14729
2540
12189
Activity
Assuming a farmer has the following proposed farm plan:
3 ha of groundnuts, 5ha of wheat and 4 ha of soya beans, produce gross margin budgets for the
farm and show the expected farm surplus.
UNIT 3
3.0 Partial Budgeting
It is a marginal analysis technique, as it looks at the changes in costs and receipts and thus net
farm income due to marginal changes in farming activities. Partial budgeting assesses financial
implications on farm activities of proposed changes. Often farmers face problems on choice of
enterprise between alternatives. The first question asked is would it pay? The other question
would be which would pay best? The partial budget gives the most precise possible forecast of
the financial effect of a proposed change.
3.1 Objectives of the Unit
By the end of this unit you should be able to:
This is done when one enterprise is substituted for another for example wheat for maize. Also
when a land using enterprise is introduced, discarded or changed in size.
ii) When changing enterprise without substitution
This occurs when non land using enterprises are introduced or expanded, discarded or reduced
for example pigs or poultry. Partial budget can be used where stocking rate of an existing area of
grassland is altered.
iii) When planning change in method of production (factor substitution)
When a change in production technique is involved for example buying a machine instead of
hiring a contractor or changing from hand harvesting to machine harvesting the budget can be
used.
3.3 Steps in Partial Budgeting
Step 1
Describe and specify proposed changes stating what is involved and other information for
example timing of change.
Step 2
List factors or items in existing system of production management that is likely to change.
Step 3
Determine gains, that is, what will contribute to increase in income this include, new income
arising out of changes and cost saved as a result of change
Step 4
Determine losses that is, what would contribute to increase in costs or reduction in income. New
costs incurred as a result of proposed change and income lost as a result of proposed change.
Step 5
Compare total gains to total costs and determine the net gain.
Partial budget to assess impact of a change to substitute 50ha of tobacco for 50ha of maize.
Losses
Lost revenue:
gross output maize
50x7.6t/hax$5700
New costs:
Variable costs tobacco
Net gain
$
2166000
19735
Gains
New revenue:
gross output tobacco
50x2000kg/ha x $170
Saved costs:
Variable costs maize
$
17000000
14460
2185735
17014460
17014460
The budget shows a positive net gain of $2 185 735. This is an expected addition to the net farm
income if this change is implemented. A net loss shows that the change is reduce net farm
income.
3.4.1 Return on Additional Investment
This ratio compares net gain to extra capital employed. For the above partial budget the ratio is
determined as follows:
Return on additional investment = net gain
Incremental capital
= net gain
New cost saved costs
=2 185 735
5275
= 414.36
3.5 Advantages of partial budgeting.
This budget is useful for the selection of profitable enterprises. When there is an intention of
introducing, discarding or reduction in size of non land enterprises this tool is most appropriate.
Decisions can quickly be made on changing production technique basing on assessments done
using the partial budget.
3.5 Limitations of Partial Budgeting;-The budget does not show the degree of risk associated
with the change. Pre-requisites required before implementing or for implementing change are not
shown. The human and social aspects like food security, labour retention or lay off are ignored.
UNIT 4
4.0 Break-even Budget
12
The break-even budget is one of the simplest yet least used analytical tools in management. It
aims to guide the farmer on minimum acceptable levels of output, prices and inputs. A
better understanding of break-even, for example, is expressing break-even sales as a percentage
of actual sales. This can give managers a chance to understand when to expect to break even.
The break-even point is where costs are equal total sales; there is no net loss or gain. A profit or a
loss has not been made, although opportunity costs have been paid.
4.1 Objectives of the Unit
After studying this unit, you should be able to:
Calculate break even output and break even sales volume.
Determine the break even input and break even cost for factors of production.
Interpret the effect of changes in output and input factors to net farm income.
Another important use of this budget is to assess viability of changes in techniques of production.
In this case a partial budget is used assuming a net gain of zero.
4.4 Graphical Representation of Break Even Volume
Table 4.1 Maize production schedule
Output (tonnes)
Gross income $
250
500
750
1000
Variable costs $
180
360
540
720
Fixed costs
140
140
140
140
Total costs
320
500
680
860
Profit region
Gross income
Total costs
Loss region
500
Fixed costs
Margin of safety
0
0
Maize in tonnes
Graphical Determination of Break Even Point
Where the gross income line crosses the total cost line, break even output can be read. In this
case it is 2 tonnes. The break even sales value is $500.
4.5 Mathematical Calculation of Break even Point
14
where y is the gross income, b is price per unit and x is the output
y = 250x
Equation 2 Total Cost Line
y = a + cx
where y is the total cost, c is cost per unit, a is the fixed costs and x is the output
y = 140 +180x
Solution
Total revenue =
Total costs
= 140
250-180
= 2 tonnes
4.5.3 Partial Budget Method
The problem quantity is assigned an unknown variable and the net gain is assumed to be zero.
Production plans for maize and ground nuts
Item
Area
3ha
3ha
Yield (t/ha)
Price $/t
265
330
Variable costs/ha
440
468
15
Losses
Income lost
Maize sales
3 x 5x 265
New costs
Groundnuts variable cost
468 x 3
Net gain
Gains
New Income
Ground nuts sales
3975 3 x y x 330
Saved costs
Maize variable cost
1404 440 x 3
NIL
5379
= Total costs
990y + 1320
= 5379
990y
= 5379 1320
y
$
990y
1320
1320 + 990y
= 4.1 Tonnes
Activity
a) Define the following terms:
i. Break even sales value
ii. Break even output
iii. Safety margin
b) sketch the following economic models
i. Determination of break even output
ii. The effect of a rise in the product price
iii. The effect of a drop in fixed costs to the safety margin
UNIT 5
5.0 CASH FLOW BUDGETING (CFB)
16
The cash flow budget is a useful financial planning tool that is concerned with the showing of
cash requirement for the period ahead. It summarises the amount and timing of cash that is
expected to flow into and out of the business during a given budgetary period. The cash flow
budget can best be seen as a technique that helps the farmer to know how much money will be
required to carry out farming operations over a period of time, and when it will be required. It is
strictly concerned with the timing of cash payments and receipts.
5.1 Unit objectives of the Unit
By the end of this unit, the student should be able to
Define a cash flow budget
Give the uses and applications of the cash flow budget
Produce the monthly, quarterly and annual cash flow budgets
Interpret a cash flow budget
Make a decision based on the cash flow budget
17
g). It is essential for a farmer wishing to obtain credit from a financial institution. Usually, it will
have to be presented together with the relevant gross margin budgets.
It is important to note that while the gross margin budget indicates income earned by an
enterprise and associated costs of the inputs used, the cash flow budget indicates the exact timing
of both receipts and payments for the same enterprise. It also has to be noted that if there is no
profit, sooner or later the farm operations will have to be stopped due to lack of funds for the
necessary inputs to keep the farm running.
5.3
Cash flow budgets are done to cover specific uniform time intervals. The duration of the time
interval used is usually determined by the nature and size of the business or enterprise, and how
long it takes to yield produce.
5.3.1
A monthly cash flow budget captures cash inflows and outflows on a monthly basis. This is
mostly convenient for agricultural enterprises since it is critical to capture the cash movements
that happen over the production cycle. Most agricultural enterprises, especially crops, are
seasonal and take less than a year to yield produce. There are however some exceptions which
include orchards and other plantation crops, as well as large ruminants.
A typical monthly cash flow budget can be made for the enterprise budgets. For each enterprise,
it is determined when exactly each input is bought, and when exactly payment for the produce is
expected to be received. This information is entered in the appropriate month. The given
example lumps similar inputs for the different enterprises.
5.3.2
TOTAL
OCT.
INCOME
Maize
Sorghum
Beef
Interest
Total Income
EXPENDITURE
Labour
Tractor Operating
Seed
Fertiliser
Chemical
Packaging Material
Feeds
Drugs
Vet charges
Household
expenses
Interest on loans
Loan repayment
Dam construction
Water charges
Electricity
Other
Total Expenses
Net cash flow
OPENING
BALANCE
CUMULATIVE
BALANCE
NOV.
19,350.00
10,752.00
19601.00
30.00
49733.00
14,512.50
6,451.20
13533.21
3,816.00
1,320.00
3,309.00
422.00
1,099.00
1,200.00
50.00
25.00
2,619.33
1,908.00
1,320.00
3,309.00
222.00
6,400.00
1,500.00
2,100.00
8,500.00
504.00
219.00
439.00
44436.21
20,963.70
DEC.
JAN.
FEB.
MAR.
4,837.50
4,300.80
6,341.50
4,035.50
4,837.50 10642.30
4,035.50
2,619.33
954.00
2,619.33
2,619.33
6,918.00
30.00
6948.00
2,306.00
2,619.33
381.60
436.56
572.40
600.00
1,099.00
600.00
2,306.00
200.00
50.00
25.00
640.00
640.00
640.00 3,200.00
640.00
640.00
250.00
250.00
250.00
250.00
250.00
250.00
350.00
350.00
350.00
350.00
350.00
350.00
6,500.00
2,000.00
125.00
95.00
65.00
59.00
90.00
70.00
30.00
25.00
32.00
43.00
37.00
52.00
300.00
39.00
100.00
17,623.33
7,197.33 3956.33 6,521.33 4,967.93 4,169.96
3340.37 -2359.83 6685.97 -2485.83
1980.07 -1863.96
4,000.00
7340.37
4980.54
7340.37
4980.54 11666.51
11666.51
9180.68
11160.75
9180.68 11160.75
9296.79
It will be noted that the actual month when a transaction occurs is indicated. The Opening
Balance indicates the amount that is in the farm business at the beginning of each month. The
Cumulative Balance is the amount that is available at the end of each period and is given by the
net receipts and previous month balance
Cumulative Balance = previous month + net cash flow for the month
The cumulative balance for any period will be the opening balance for the next period. For
instance, the cumulative balance for October will be the opening balance for November.
19
INCOME
Maize
Potato
Soyabean
Broilers
Dividends
Total Income
EXPENDITURE
Labour
Tractor Operating
Seed
Fertiliser
Chemical
Packaging Material
Electricity
Rentals
Household expenses
Loan repayment
Interest on loans
Total Expenses
Net cash flow
OPENING BALANCE
CUMULATIVE
BALANCE
TOTAL
12,000.00
9,600.00
2,500.00
4,152.00
770.00
29022.00
8,350.00
3,625.00
2,100.00
3,150.00
312.00
85.00
140.00
300.00
3,470.00
1,000.00
250.00
22,782.00
1,053.00
450.00
1503.00
900.00
2,000.00
960.00
350.00
2,800.00
312.00
1,950.00
765.00
1,750.00
900.00
3,500.00
6,700.00
1,750.00
1,504.00
320.00
13774.00
8,500.00
2,900.00
750.00
695.00
12845.00
2,250.00
1,280.00
2,150.00
620.00
350.00
32.00
75.00
1,500.00
250.00
62.50
8,341.50
-6838.50
1,000.00
45.00
45.00
75.00
800.00
250.00
62.50
5,742.50
-4842.50
-5,838.50
40.00
28.00
75.00
650.00
250.00
62.50
4,635.50
9138.50
-10681.00
35.00
75.00
520.00
250.00
62.50
4,062.50
8782.50
-1542.50
-5838.50
-10681.00
-1542.50
7240.00
Calculations of the cumulative balance are done in the same manner as they are done for the
monthly cash flow budget.
5.3.4
20
The annual cash flow budget is useful for big projects with a relatively long life span. It is
necessary for the purposes of determining whether a farmer will be able to repay a loan. As such,
the budget uses yearly periods.
5.3.5
INCOME
Maize
Potato
Soya bean
Eggs
Pork
Interest
Dividends
Total Income
EXPENDITURE
Labour
Tractor Operating
Seed
Fertiliser
Chemical
Packaging Material
Electricity
Rentals
Household expenses
Interest on loans
Total Expenses
Net cashflow
OPENING BALANCE
CUMULATIVE
BALANCE
TOTAL
11,175.00
32,150.00
18,195.00
20,420.00
14,930.00
750.00
1,315.00
98935.00
2,400.00
5,750.00
3,750.00
4,290.00
2,780.00
150.00
345.00
19465.00
2,550.00
7,000.00
4,020.00
4,300.00
3,110.00
150.00
220.00
21350.00
5
3,750.00
9,500.00
5,575.00
5,520.00
3,890.00
150.00
400.00
28785.00
-3935.00
-2200.00
-1010.00
6085.00
= (1+r/m) m -1
ER
= (1.06)2-1
=12.36%
Interest
=$500 x 0.1236
= $61.80
5.4.1 Calculation of Interest on Credit Balance
Assuming a credit balance of $1000 for a month at 12% per annum charged monthly, calculate
interest received as follows:
An =1000 (1+r/m) m n
= 1000 (1.12/12)12
= 1000 (1.01)12
= $1126.83
Interest =An -p
=$ 1126.83-1000
=$126.83
5.5 Advantages and Disadvantages of Using Cash Flow Budgets
5.4.1 Advantages
Cash flow budgets assist management to detect periods of cash deficits and so enable
arrangements to be made on time to look for alternative sources. Any extra cash can be properly
planned and either used for further expansion of the business or investment on the money
market.
5.4.2 Disadvantages
Cash flow budgets are estimates of future receipts and payments hence they can not be precisely
accurate. The price regime may change during the course of the budgetary period rendering the
budgets useless.
Activity
a) Define the following terms as used in cash flow budgets
i. Quarterly cash flow budgets.
ii. Cash inflow
iii. Cash out flow
iv. Cumulative balance.
22
b) Give possible reason why a particular time period gives negative net cash flow.
c) Comment on the cash inflows and cash out flows for layers, piggery and maize with regards to
timing of flows.
REFERENCES
23