Partial Budgeting AAE 320 Paul D. Mitchell

Goal Explain purpose of partial budgets Illustrate their structure and use Give some examples

Partial Budget Purpose To analyze net gain from small changes or refinements to farm operation Partial Budget: focus only on the parts that change, do not need to completely budget each enterprise Use to fine tune current operation: Hold all else fixed to evaluate a small change Marginal/incremental analysis: change input use, shift between inputs or between outputs

Simple Examples to Analyze Using Partial Budget Analysis Do I plant rootworm Bt corn or conventional corn with a soil insecticide? Do I rent an additional 80 acres for corn? Do I buy a combine or continue custom hiring? Do I sell my current tractor and buy a new one? Do I pay for a soil test for N or just use credits?

Partial Budget Basic Idea Benefits: 1) What will be the new or added revenues? 2) What costs will be reduced or eliminated? Costs: 3) What will be the new or added costs? 4) What revenues will be reduced or lost? Partial Budget: Answer these 4 questions and then calculate Net Gain = Benefits – Costs

Partial Budget: Define the change analyzed Benefits Costs Additional Revenues What will be the new or added revenues? Additional Costs What will be the new or added costs? Costs Reduced What costs will be reduced or eliminated? Revenues Reduced What revenues will be reduced or lost? Total Benefits Total Costs Total Benefits – Total Costs = Net Gain

Planter Example Look at buying a planter for 1000 acres of corn and soybean versus custom hire What will be the new or added revenues? Increased yields due to more timely planting What costs will be reduced or eliminated? No longer pay for custom planting What will be the new or added costs? Fixed and variable costs of owning a planter What revenues will be reduced or lost? I can’t think of any

Buy planter vs. custom hire for planting 1000 acres corn-soybeans (500 acres each) Additional Revenues What will be the new or added revenues? Higher yields with more timely planting Additional Costs What will be the new or added costs? Fixed and variable costs of owning a planter Costs Reduced What costs will be reduced or eliminated? No longer pay cost for custom hire Revenues Reduced What revenues will be reduced or lost? None Total Benefits Total Costs Total Benefits – Total Costs = Net Gain

Buy planter vs. custom hire for planting 1000 acres (500 each) corn-soybean Additional Revenues 3 bu corn x $3.00/bu x 500 ac = $4,500 1 bu soybeans x $9/bu x 500 ac Additional Costs Corn $15/ac x 500 ac = $7,500 Soybeans $12/ac x 500 ac = $6,000 Costs Reduced Custom corn planting = $20/ac x 500 ac = $10,000 Custom soybean planting = $16/ac x 500 ac = $8,000 Revenues Reduced None Total Benefits $27,000 Total Costs $13,500 Total Benefits – Total Costs = Net Gain

Planter Example Only focus on costs and revenues that change Estimate 3 more bu of corn and 1 more bu of soybeans due to more timely planting Corn = 1% loss/day in WI after May 8 Soybeans: 0.25/bu/day in IA study Estimate cost of owning and operating a planter: “Estimating Farm Machinery Costs” (ISU Extension https://www.extension.iastate.edu/agdm/crops/html/a3-29.html) Custom rates: Rounded 2016 Iowa Custom Rates: https://www.extension.iastate.edu/agdm/crops/pdf/a3-10.pdf Is $13,500 ($13.50/ac) enough to justify the added hassle of owning and operating a planter?

Think Break #1 Suppose you are a corn-soybean farmer who currently custom hires all combining. You are thinking of buying a combine. Do a partial budget analysis of a Combine Purchase vs. Custom Hire decision Needed assumptions/information and questions are given in the next slide

Think Break #1 Combine Purchase vs. Custom Hire Corn acres = 1,000 Custom Rate = $25/acre Cost Estimate if owned: $22/acre 1% yield increase with more timely harvest Average Yield = 180 bu/ac; Expected Price = $3/bu 1) What will be the new or added revenues? 2) What costs will be reduced or eliminated? 3) What will be the new or added costs? 4) What revenues will be reduced or lost? 5) What’s the net gain?

Partial Budget: Think Break #1: Combine Purchase vs Custom Hire Benefits Costs Additional Revenues Additional Costs Costs Reduced Revenues Reduced Total Benefits Total Costs Total Benefits – Total Costs = Net Gain

Another Example: See how detailed it can become Add 50 beef cows to your cow-calf herd and convert 100 acres from grain to forage 1) What will be the new or added revenues? 2) What costs will be reduced or eliminated? 3) What will be the new or added costs? 4) What revenues will be reduced or lost? 5) What’s the net gain?

Revenue Benefits 1) What will be the new or added revenues? Sell more steers, heifers, and cull cows 46 calves (92% efficiency) Save 5 heifers as replacements (10% cull rate) 23 steer calves x 500 lbs x $1.25/lb = $14,375 18 heifer calves x 460 lbs x $1.20/lb = $9,936 5 cull cows $500 each = $2,500 Total = $26,811

Cost Benefits 2) What costs will be reduced or eliminated? Variable inputs used for grain production Fertilizer, seed, pesticides, etc.: $5,350 Labor: $1,500 Variable machinery costs: $1,000 Interest on variable costs @ 6% = $470 Total = $8,320

Cost Costs 3) What will be the new or added costs? Fixed costs Interest on cows and bulls = $2,500 Bull depreciation = $300 Variable costs Labor = $600, Vet and health = $500 Feed/Hay = $2,000, Pasture fertilizer = $1,500 Hauling and Miscellaneous = $500 Interest on variable costs @ 6% = $300 Total = $8,200

Revenue Costs 4) What revenues will be reduced or lost? Grain production from 100 acres Corn: 160 bu/ac x $3.00/bu x 100 ac = $48,000 Soybeans: 40 bu/ac x $9.00/bu x 100 ac = $36,000 Use half of each, since 2 year rotation Total = ½ ($48,000 + $36,000) = $42,000

Partial Budget: Add 50 cows to cow-calf operation and convert 100 acres to forage Benefits Costs Additional Revenues 23 Steer calves, 18 heifer calves and 5 cull cows = $26,811 Additional Costs Fixed and variable costs for 50 more cows and needed bulls = $8,200 Costs Reduced Variable inputs for grain production = $8,320 Revenues Reduced Revenue from corn-soybean production = $42,000 Total Benefits $35,131 Total Costs $50,200 Net Gain –$15,069

Comments on Analysis Needed more complete enterprise budgets for cow-calf and grain & forage operations Fixed cost added for cows and bulls, but no fixed cost change for crop conversion from grain to forage. Why? Labor for cow-calf less than for grain ($600 vs. $1,500), an added benefit—What will you do with the extra time?

Final Comments on Partial Budgets Some things to consider when using partial budget analysis Economies of Size Opportunity Costs Sensitivity Analysis Risk Changes

Economies of Size Partial budget analysis assumes linear or proportional changes in costs and revenues Likely not quite accurate, but a useful and simple approximation Adding 20 cows to herd of 200 will increase labor demand, but less than 10% Dropping 100 acres from 1000 acre grain farm will decrease costs, but less than 10% Main Point: Linear (proportional) approximation is fine for small changes, but not for large—need more complete budgeting if examine a large change

Opportunity Costs Should be included in the analysis Capital needs change: include costs (benefits) for borrowing more (less) money or tying up more (less) of your capital in farm assets Labor and Management changes: include the costs/benefits of your and your family's time commitment changes Change farm operation due to changes in credit or labor resources or desires

Sensitivity Analysis Assumptions used to construct partial budgets not always known with certainty Yield benefit for more timely planting Crop yields and prices Machinery costs Run analysis with a range of assumptions Low, average, high, worst or best case scenario Find break even price or yield and decide how likely Formally model the uncertainty: use probability distributions, decision trees, or pay off matrices and do Monte Carlo risk analysis

Risk and Partial Budgeting Partial Budgeting ignores changes in risk Converting 100 acres from grain to forage and adding 50 cows to cow-calf operation: What are the risk implications? Without formal “tools”, comparisons ignore risk, or you bring it in afterwards in ad hoc way “The financial risk of owning a planter is too great to justify the $1,380 net benefit” “The risk of not finding a custom combiner is too great to justify the $6,900 net gain if I switch to using custom combining

More Information Partial Budgeting a common tool in ag, use Google to find examples Partial Budgeting: A Tool to Analyze Farm Business Changes (ISU Extension) Partial Budget Analysis (NDSU Agriculture Law and Management)

Summary Explained and illustrated the purpose of partial budgets Did examples, including Think Break #1 Explained some issues/weaknesses of partial budgets (size economies, opportunity costs, sensitivity analysis, risk) For problem set and exam: be able to make simple partial budget using given information and interpret findings