Chapter 11: Partial Budgeting

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Chapter 11 Partial Budgeting
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Objectives

• Discuss purpose of partial budget
• Emphasize possible uses of partial budget
• Illustrate format of partial budget
• Note importance of including only changes in
  revenue and expenses
• Demonstrate the uses of partial budget with
  examples

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Uses of Partial Budget

• Deciding whether to increase the size of, or to
  eliminate a small herd of beef cows
• Deciding whether to buy harvesting equipment or
  hire custom harvest
• Deciding whether to plant more barley or less
  wheat

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Partial Budget

• Compares profitability of what is being done now
  with a proposed change
• Emphasis on CHANGE
• Analyzed small changes in a farm business

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Partial Budgeting Procedure

• Changes in costs and revenues must be identified
• Specifically,
• 1) Additional costs?
• 2) Reduced costs?
• 3) Additional revenue?
• 4) Reduced revenue?
• Remember, only changes are included, not total
  costs or total revenues

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Partial Budget Format

• Problem
• Additional Costs Additional Revenue
• Reduced Revenue Reduced Cost
• Total Additional Costs Total Additional
  Revenue
• And Reduced Revenue ____ And Reduced Cost
  ____
• Net Change in Profit ____

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Additional Costs

• Additional costs costs that do not exist at the
  current time with the current plan
• A proposed change may cause additional costs due
  to new or expanded enterprises requiring more
  inputs

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Reduced Revenue

• Reduced Revenue revenue currently being received
  but which will be lost or reduced should the
  alternative be adopted
• Revenue may be reduced because if enterprise is
  eliminated
• Must carefully account for information about
  yields, output selling prices, and livestock
  growth and birth rates

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Additional Revenue

• Additional Revenue revenue to be received only
  if the alternative is adopted it is not being
  received under the current plan
• Can be received if a new enterprise is added or
  expanded
• Must pay careful attention to prices and yield
  estimates

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Reduced Costs

• Reduced Costs cost now being incurred that would
  no longer exist under the alternative being
  considered
• Can result from eliminating an enterprise,
  reducing the size of an enterprise, or reducing
  input use

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Partial Budget

• Categories on left-side reduce profit (additional
  costs and reduced revenue)
• Categories on the right-side increase profit
  (additional revenue and reduced costs)
• The two entries are summed and then compared to
  determine the net change in profit

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Example 1

• Analyze the profitability of purchasing a combine
  to replace the current practice of custom hiring
  1000 acres of wheat
• Cost or revenues of wheat production will not be
  included in this budget because they are the same
  under either alternative

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Problem purchase combine to replace custom
hiring (1,000 acres of wheat) Additional
Costs Additional Revenue Fixed
costs depreciation 10,000 None interest
8,000 taxes 100 insurance
300 Variable costs repairs 2,500 fuel and
oil 1,300 labor 550 Reduced
Revenue Reduced Cost None Custom
combining charges 1000 acres _at_ 20 acre
20,000 Total Additional Costs Total
Additional Revenue And Reduced Revenue 22,750
And Reduced Cost 20,000 Net Change in
Profit -2,750
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Example 1

• Purchasing combine increases fixed costs such as
  depreciation, interest, taxes, and insurance
• Variable costs increase as well (repairs, fuel
  and oil, and labor)
• No revenue is reduced
• Total additional costs and reduced revenue 22,
  750

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Further Analysis

• How much would the charge for custom harvesting
  have to increase to make purchasing the combine
  the better alternative?
• What if the combine was used to do custom work
  for others?

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Example 2

• Suppose you want to add 50 beef cows to an
  existing herd
• However, not enough forage is available, and 100
  acres of wheat must be converted to forage
  production

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ProblemAdd 50 beef breeding cow and convert 100
acres from grain to forage production Additional
Costs Additional Revenue Fixed
costs interest on cows/bulls 2,500 5
cull cows 2,500 bull depreciation
200 23 steer calves taxes
100 500 lb. _at_ 0.85
9,775 Variable costs 18 heifer
calves labor 600 460 lb. _at_ 0.78
6,458 vet and health
500 feed and hay 2,000 hauling
300 misc.
200 pasture fertilizer
1,500 interest on variable costs
320 Reduced Revenue Reduced Cost Grain
production Fertilizer
2,750 5000 bu _at_ 3.00 15,000 Seed
1,400 Chemicals
1.200 Labor 1,500 Machinery
1,000 Interest on
variable costs 47 Total
Additional Costs Total Additional
Revenue And Reduced Revenue 23,220 And
Reduced Cost 27,053 Net Change in
Profit 3,833
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Example 2

• ADDITIONAL COSTS
• Increased Fixed Costs additional interest on
  increased investment, depreciation on additional
  bulls, additional property taxes on the new
  animals
• Increased Variable Costs labor, health cost,
  feed, hauling, fertilizer for new pasture, and
  interest on variable costs

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Example 2

• REDUCED REVENUE
• Grain production on 100 acres
• 5,000 bu. _at_ 3.00 bu 15,000
• TOTAL ADDITIONAL COSTS AND REDUCED REVENUE
• 23,220

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Example 2

• ADDITIONAL REVENUE
• Assume 5 culls cows (500 hd.)
• 23 steer calves (500 lb. _at_ 0.85)
• 18 heifers calves (460 lb. _at_ 0.78)

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Example 2

• REDUCED COSTS
• Fertilizer, seed, chemicals, labor, machinery,
  interest on variable costs
• TOTAL ADDITIONAL REVENUE AND REDUCED COSTS
• 27,053
• NET CHANGE IN PROFIT
• 3,833

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Factors to consider

• Suppose the proposed change is a 20 increase in
  the size of an enterprise
• Not correct to increase revenues and expenses by
  20
• Fixed costs do not change unless an additional
  capital investment is required
• Even variable costs do not change proportionally

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Final Considerations

• Before adopting changes that appear to increase
  profit, any additional risk and capital
  requirements should be carefully evaluated
• Is the additional profit from adding beef cows
  more variable than the profit from the 100 acres
  of wheat production?
• Is the additional profit worth the risk?
• If additional money is borrowed, how will this
  affect the financial structure of the business,
  risk, cash flow requirements, and repayment
  abilities?

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REMEMBER, PROFIT IS MADE BY UNDERSTANDING THE
FINANCIAL STRUCTURE OF YOUR BUSINESS AND
BUDGETING OUT ALTERNATIVES TO IMPROVE (INCREASE
PROFITS) YOUR BUSINESS