Enterprise Budgeting

1. Enterprise Budgeting AAE 320 Paul D. Mitchell

2. Goal • Explain enterprise budgets: their purpose and use • Illustrate enterprise budgets: their different parts • Learn how to construct and use enterprise budgets

3. Purpose of Enterprise Budgets • To estimate projected costs, revenue, and net returns for a single enterprise to assess feasibility or profitability of current or potential enterprises • How much will I make on corn and soybeans? • Planning tool to test out new ideas and compare enterprises to identify best ones • How profitable would wheat be? • How do snap beans compare to soybeans?

4. Purpose of Enterprise Budgets • Estimate needs for inputs, facilities and storage, and marketing • For your crops • How much fertilizer, seed, chemicals do you order? • Do you need new/bigger equipment? • How much grain storage and marketing do need? • For your livestock • How much feed and bedding do you need? • How much can you grow and how much buy? • What about hired labor?

5. Enterprise Budgets • Usually “Enterprise” = a crop or livestock • Corn, soybeans, wheat, alfalfa • Dairy, feeder beef, cow-calf, hogs • Specialty crops: sweet corn, trout, mink • Conventional vs no-till • Grazing vs. confinement

6. Enterprise Budgets • Use a constant base unit • Crops = 1 acre Livestock = 1 head • Allows comparison across enterprises • Compare wheat to corn and soybeans • Compare farrow-to-finish to finishing only • Each enterprise budget a “Lego” • Snap “Legos” together to make your farm

7. Parts of Enterprise Budget • Revenues – Costs = Returns • No formal structure as for balance sheet or income statement • Cost categories used • Variable/Operating Costs • Fixed/Ownership/Overhead Costs • Machinery costs • Split into fixed and variable costs? • Lump together into own category? • Opportunity Costs • Which ones included, which ones ignored • Time line version: Planting Costs, Harvest Costs

8. Examples • Illustrate diversity in enterprise budgets All for Corn following Soybeans • Iowa: “Crop Production Cost Budgets” www.extension.iastate.edu/agdm/crops/pdf/a1-20.pdf • Illinois: “Crop Budgets” http://www.farmdoc.uiuc.edu/manage/newsletters/fefo09_06/FEFO_09_06.pdf • Wisconsin: “Crop Enterprise Budget” http://www.cdp.wisc.edu/wk1/Corn%20after%20Soybeans%20Budget%20for%20Wisconsin.xls http://www.aae.wisc.edu/mitchell/Corn%20Soybeans%20Small%20Grains.xls • Main point: No “right” way to do enterprise budget

9. Enterprise Budgets and You • Costs and returns to the same enterprise vary greatly among producers • Lots of example enterprise budgets and returns projections available • Do not accept someone else’s enterprise budget for the cost and returns for growing corn, soybeans, dairy, beef, etc. as your costs • You need to know your own costs, not someone else’s estimate or the typical costs

10. Corn Minnesota Data for 1996 Source: Kent D. Olson and Heman D. Lohano. 1997 “Will the Real Cost of Production Please Stand Up?” Minnesota Agricultural Economists No. 687 http://www.extension.umn.edu/newsletters/ageconomist/components/ag237previous.html Soybeans

11. Illinois Data for 2006 Source: Gary Schnitkey “Crop Production Cost and Rotation Decisions” http://www.farmdoc.uiuc.edu/IFES/2007/presentations/Farm Economic Summit - Schnitkey.pdf

12. Enterprise Budgets • Concept not hard: Revenues – Costs = Returns • Revenue easy to estimate: Price x Yield • If you already grow it, you should know • For common crops and livestock, prices and typical yields available from many places • Variable input costs easy too • If you already grow it, you should know • Price x quantity use per acre • Internet or call around for prices, typical use rates

13. Enterprise Budgets • Cost estimation difficult for machinery, buildings, facilities, equipment, etc. • What does it cost to chisel plow a field? • What is the annual cost of a dairy barn? • What portion of tractor repair should be allocated to soybean production? • Machinery Costs as an Example

14. Machinery Cost Concepts • Substantial component of costs (25%-40%) • Difficult to measure/estimate: user specific • Variable Cost, Use-Related Cost, Operating Cost • Costs due to using the machinery • Fuel, lube, maintenance, use-related repairs and labor • Fixed Cost, Time-Related Cost, Overhead Cost • Costs paid whether you use the machinery or not • Interest, insurance, taxes, housing • Depreciation: both a variable and fixed cost

15. Machinery Costs • Best method: keep accurate records of machinery use (hours) for each enterprise, expenses (fuel, repairs, maintenance), and current market value and use them to determine your Actual Machinery Costs for each enterprise • Most farmers don’t do this • Estimate Machinery Costs if you do not have records or you are looking at new options • Economic Engineering Approach • Adjust Custom Rates

16. Economic Engineering Approach • Estimate machinery costs based on careful engineering data collection • Use the machinery and carefully document • repairs, maintenance, fuel/lubrication • speed, turning time, labor • Develop formulas to estimate fixed and variable machinery costs • Market data and survey of used machinery buyers/sellers to develop formula for machine values as they age

17. UW Resources • Ron Shuler (UWEX-BSE): Updated A3510 “Estimating Ag. Field Machinery Costs” • Bulletin with worksheets • Spreadsheet • Official A-series publication • http://www.aae.wisc.edu/aae320/Budgets/A3510.pdf • http://www.aae.wisc.edu/aae320/Budgets/Machinery%20Costs%20A3510.xls

18. Other Resources • William Edwards (IA Extension-Econ): “Estimating Farm Machinery Costs” • Bulletin with worksheets • www.extension.iastate.edu/Publications/PM710.pdf • Lazarus and Selley (MN) “Farm Machinery Economic Cost Estimates for 200Y” • Bulletin with fixed and variable costs for different machinery operations • Lots more on machinery management • http://www.apec.umn.edu/faculty/wlazarus/documents/mf2008.pdf

19. Main Idea • Fixed Costs: depreciation, interest, taxes, insurance, housing • Variable Costs: repairs and maintenance, fuel, lubrication, labor, (timeliness) • Usually simple factors: • For example: 1% of purchase price for cost of insurance and housing • Fuel = 0.044 x PTO HP x hours of use x fuel price • Lubrication = 0.15 x Fuel Cost • Repairs and maintenance = % x new purchase price, with % adjusted for age or total use hours • See the publications for more information

20. Machinery Cost Example • What does it cost to run a chisel plow? • Lazarus and Selley 2005 (23 ft): $6.81/ac • Iowa 2005 Custom Rate $11.05/ac • Wisconsin 2004 Custom Rate : $13.30/ac ($14.70/ac in WI 2007 Custom Rate) • Indiana 2004 Custom Rate $11.78/ac • South Dakota (East) Custom Rate: $10/ac • Missouri 2003 Custom Rate $10/ac ($12.10/ac heavy soil) • SW Minnesota 2001: $10.83/ac

21. Why not just use Custom Rates? • Custom rates not good estimates of typical farmer costs—usually too low • Run over more acres, spread fixed costs • Volume discounts or search for best price, so lower purchase price • More efficient operators • Family/friends not charge enough • Discounted because not perfect timing

22. Adjusting Custom Ratesto Estimate your Cost • Adjusting custom rates is an easy way to estimate typical machinery costs • K. Dhuyvetter and T. Kastens at Kansas State University developed a formula using KFMA cost data and custom rates www.agmanager.info/farmmgt/machinery/MF2583.pdf • UWEX bulletin and Spreadsheet “Fast and Simple Method to Estimate Machinery Costs" www.aae.wisc.edu/mitchell/Fast and Simple Method.pdf

23. Scale Factor Calculation • Scale Factor = 1.241 + (33.026/acres) • Acres is annual acres operated • Your Cost = Scale Factor x Custom Rate • If you operate 1500 acres, then Scale Factor = 1.241 + (33.026/1500) = 1.263 • Means your costs are 26.3% greater than the custom rate for a machinery operation

24. 1.55 Acres Scale Factor 100 1.571 1.50 200 1.406 1.45 300 1.351 400 1.324 1.40 500 1.307 Scale Factor 600 1.296 1.35 700 1.288 1.30 800 1.282 900 1.278 1.25 1000 1.274 1.20 1100 1.271 0 500 1000 1500 2000 2500 3000 1200 1.269 Acres of Cropland 1300 1.266 1400 1.265 1500 1.263 1600 1.262 1700 1.260 1800 1.259 1900 1.258 2000 1.258 1 – Scale Factor = % increase (as decimal) that your costs exceed the Custom Rate

25. Caveats • Custom rates have wide ranges—call around, use Custom Rate Guides from Wisconsin and surrounding states http://www.aae.wisc.edu/aae320/Budgets/WI_custom_rates_2007.pdf • Formula to adjust custom rates not perfect • Use these machinery costs as a • Guide to estimate typical costs • Benchmark for comparison • Method is not your actual costs for machinery • Need good records to estimate actual costs

26. Think Break #19 • Estimate a typical cost to chisel plow a field for a farm of your size using the Fast and Simple Method a) Local custom rate is $16/ac b) You run 1800 acres of crop land • Remember: Scale Factor = 1.241 + (33.026/acres) Typical Cost = Scale Factor x Custom Rate

27. Enterprise Budget Example: Corn • Budget Template to implement this “Fast and Simple Method” • Work through an example

28. Crop Budgets Special Cases • Crops such as alfalfa and pasture • Create separate budgets for establishment and non-establishment years, then include pro-rated cost of establishment on the non-establishment year budget • Establishment is $120/ac, non-establishment is $25/ac for 3 more years, so add $120/4 = $30/ac • Orchards, vineyards, etc.: do net present value analysis of the entire cost stream • Storage, transportation, marketing, etc.: some crops large cost (vegetables, fruits) for these expenses, with different prices by sale date

29. Livestock Enterprise Budgets • Many exist, many different ways used • Unit: one cow, one hog, one ewe, etc., or one sow-litter, cow-calf, ewe-lambs, etc. • Time period: hogs, flocks: more than one per year, others longer than one year, so adjust all costs to the same time period • Machinery, facilities, and equipment: fixed and variable costs just as for crops

30. Livestock Enterprise Budgets • Multiple Outputs: milk, cull cows, calves • Adjust to one “cow unit” = 24,000 lbs milk, 0.39 cull cows, 0.52 calves, and 0.21 replacement heifers produced per year • Include death loss and < 100% calving • Examples • Iowa State University • http://www.extension.iastate.edu/agdm/livestock/html/b1-21.html • Center for Dairy Profitability & Team Forage • http://www.cdp.wisc.edu/Decision%20Making%20Tools.htm • http://www.uwex.edu/CES/crops/uwforage/dec_soft.htm

31. Livestock Enterprise Budgets • Raised crop used for livestock feed • Cost for livestock use should be its opportunity cost—the cost if you had to buy the grain • Credits crop with the full value of its production • Manure used as crop fertilizer • Cost to crop at its opportunity cost—the cost if you had to buy the equivalent fertilizer • Credits livestock with full value of its production • Delivery/Hauling costs for grain and manure • Charge all to one enterprise or split between?

32. Break-Even Yield and Price What yield or price do you need to break even on the enterprise? Break-Even Yield: At a given price, the yield needed to cover all costs Break-Even Yield = Total Cost/Output Price Break-Even Price: For a given average yield, the price needed to cover all costs Break-Even Price = Total Cost/Average Yield

33. Allocating Overhead Costs • Farms overhead costs must be allocated across all enterprises • Workshop costs, membership dues, insurance, legal fees, accounting costs, taxes, utilities, office costs, etc. • These costs should be declared on Schedule F, with depreciation tracked in farm records • Enterprise budgets often miss these or similar costs

34. Whole Farm Budget • Budgeting system based on Schedule F to allocates ALL costs • 3 year average of costs for each Schedule F category to “avoid” accrual adjustments • Income Statement: better base to allocate costs from, but not all farms have • Main idea: Allocate % of Schedule F cost to each enterprise, all costs allocated • Examples Potatoes and Veggie Compass

35. Summary • Defined & presented example Enterprise Budgets • Details on machinery costs: Economic Engineering vs Custom Rates approach • Fixed Costs: depreciation, interest, taxes, insurance, housing • Variable Costs: repairs and maintenance, fuel, lubrication, labor • Example Budget Template • Special Cases: Livestock, Perennial Crops • Allocating Overhead: Schedule F and Whole Farm Budget • Example Budget Template (Potatoes)