Using Enterprise Budgets for Cost and Returns Estimation

Introduction to key concepts

Bart EleveldExtension Economist

Agricultural and Resource Economics Department

What is an Enterprise Budget?

• An estimate of the costs and returns associated with the production of one unit of a product.– An acre of wheat– One cow in a cow-calf herd– One litter in a hog enterprise– One ewe in a sheep flock

What is an Enterprise Budget?• Shows the organization of resources

necessary for production– Labor– Machinery– Materials– Operations

• Built on assumptions about the complete farm/ranch– Size and location– Nature of other enterprises

How are Enterprise Budgets Used by Farmers and Ranchers?

• Important component in farm business plan• Basis for other budgets

– Cash flow, Whole farm, Capital, Partial• Evaluating enterprise mix

– Which enterprises are profitable, which not?• Aid in marketing

– What price do I need to break even (cover my costs)?• Cost control

– How can I produce more efficiently?• Substitute (poor but better than nothing) for enterprise

accounting• Machinery decisions

– Should I own, rent or (custom) hire machinery?

Other Users of Enterprise Budgets

• Potential new farmers• Lenders• Assessors• Appraisers• Lawyers• Product buyers• Commodity organizations• Legislators• Policy Makers

Where Can I Find Enterprise Budgets?

• Oregon– www.oain.oregonstate.edu click enterprise

budgets• Other states:

– http://www.economics.nrcs.usda.gov/care/

Components of Enterprise Budgets

• Income• Variable costs• Fixed costs• Break-even analysis

– Difficult in livestock if multiple products• Machinery costs

Income

• Easy to calculate but hard to settle on• Use representative prices and yields

– i.e., some kind of average or “typical” of past performance

Variable Costs

• Occur only if production occurs• Usually have a relationship with yields

– If not direct, then can be avoided by not producing• Grouped by stages of production

– listed in order they occur• May include both cash and noncash costs• VC must be covered in short run or producer

would be better off quitting production• As production season progresses, variable

costs become fixed in nature

Cost Curves Diagram$

$/Q

Q

Q

Total Cost

Total Variable Cost

Total Fixed Cost

Marginal CostAve. Total Cost

Ave. Variable Cost

Ave. Fixed Cost

Price

Variable Cost Items• Fertilizers and chemicals• Seeds and plants• Supplies• Custom charges• Machinery costs

– Fuel, lube, oil, repairs

• Hired labor• Operator labor opportunity cost (?)• Livestock expenses

– Feed, minerals, vet expenses, fence maintenance

• Operating capital interest

Fixed Costs

• Incurred whether production happens or not– Once the durable assets are obtained

• Independent of level of production• In short run, don't influence production

decision• Can include cash and noncash items • Vary greatly among farms/ranches

Fixed Cost Items (DITI)

• Depreciation (economic, not tax)• Interest

– Noncash opportunity cost for equity– Cash for borrowed capital

• Taxes (property, not income)• Insurance• Amortized establishment for perennials• Remember, they are avoidable (variable) if

the assets have not yet been acquired

Break-Even Analysis

• Price needed to cover all, or variable costs (at a given yield)– Pricebev = Total Var. Cost / Yield– Pricebet = Total Cost / Yield

• Yield needed to cover all, or variable costs (at a given price)– Yieldbet = Total Cost / Price

Machinery Costs (Crops)• Often represent one of largest cost on crop

budgets• Includes variable (operating) and fixed

(ownership) costs• Labor includes time to do operation plus setup

and transport• Fuel, lube and oil are calculated based on field

time• Repairs calculated by engineering equation

unless you have records

Machinery Costs (cont'd)• Depreciation is straight line (economic)• Current market value is average of list price and

salvage value• Interest is based on average (current market

value)• Often felt to be overstated in budgets• Our half-used, current equipment assumption

insures that there is enough cost to keep inventory current

• Shared use by other enterprises can have large impact on fixed costs

Presentation Formats• Operations approach

– All operations are listed with associated labor, machinery and materials/other expenses

– Gives a "cookbook" that helps producers figure their own costs when they “do it”differently than the published budget

• Resource (input) category approach– Lumps all like input expenses together (e.g.,

fuel, fertilizer, pesticides, machinery, etc.)– Shorter, simpler format more useful for

nonfarmers, and for some simple adjustments

Notice that inputs are “grouped or lumped together” by categories, not by operations.

This makes it easier to adjust for simple price and quantity changes, but difficult to adjust for doing different operations.

Interpretation• Point on (or even under) a production function --don't represent any

single firm• Not statistical estimates• Budgets are not precise -- figures carried to cents doesn't imply that

precision• Economic, not accounting returns --opportunity costs are used

extensively• Negative net income doesn't necessarily imply farmers shouldn't

produce– May tolerate negative returns in one enterprise in order to make

large positive returns in another– Opportunity cost rates (interest, labor) may be too high

Demonstration of Crop Enterprise Budget Calculator with Annual Crop• Snap beans, Willamette Valley• Demonstrate:

– Revenues– Add & delete operations and materials– Show break-evens– Sensitivity (risk) analysis– Fixed cost estimation by allocation

Cost of Establishing and Producing a Perennial

Year 0 (grd prep)

- Variable costs

- Fixed costs

= (Net return)

Year 1 (plant)

- Variable costs

- Fixed costs

= (Net return)

Year n (last est. yr.)

+ Returns

- Variable costs

- Fixed costs

= (Cum. Net return)

● ● ●

+ Interest+++ Interest

Full Prod. Years

+ Returns

- Variable costs

- Fixed costs

= Net return

Amortized Establishment

(Principal + Interest) pmt.

Cumulative Net ReturnsMachine Picked Blueberries, Willamette Valley

-20,000.00

0.00

20,000.00

40,000.00

60,000.00

80,000.00

100,000.00

-6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

Year

Cumulative gain (loss) Cumulative "cash" flow

Recovery of “actual”expenses

Recovery of all expenses including interest on perennial stand

Basic Assumptions• Ground fallow to begin, prepared fall yr. 0, planted spring yr. 1• 7 years of establishment (including yr. 0) and 25 years of full

production• 20 acre field, plants 3’ x 10’ spacing• Capital costs are in 2004 values• Immature crops all hand picked for fresh market• Mature: compare machine vs. hand picked

– Machine: all machine for processed– Hand pick: 90% hand pick for fresh, 10% machine clean-up for processed

• Labor @ $11.00/hr including benefits, all labor is charged• Interest @ 7% intermediate-term, 8% short-term• Irrigation (overhead) installed in year 1 @ $1,100 per acre• Trellis added in Year 2 @ $700 + 30 hours of labor per acre• Land lease cost: $400/ac. (can be proxy for ownership cost)

Yield Maturation During EstablishmentYear Production

3 3600

4 7200

5 10800

6 14400

Full (hand)(machine)

1800016000

Machine Harvest Full Production Budget

Economic SummaryPredicted Result Machine Harvest Hand Harvest

Assumed Prices $0.50 processed $ 0.85 fresh (90%)$ 0.50 proc. (10%)

$ 0.82 wtd. ave.

Assumed Yield 16,000 lb. processed 16,200 lb. fresh (90%)1,800 lb. processed (10%)

Total Revenue $ 8,000 $ 14,670

Variable Costs $ 3,948 $ 8,910

Fixed Costs $ 1,519 $ 1,519

Net Revenue $ 2,533 $ 4,242

Break Even* Price $ 0.383 (total cost) $ 0.644 (fresh)

Break Even Yield 10,531 lb. 9,917 lb. total

* Break even is defined as recovery of all costs, including opportunity costsof investment, by the end of the stand’s productive life

Break-Even Prices or YieldsCumulative Net Returns

Machine Picked Blueberries, Willamette Valley

-20,000.00

-15,000.00

-10,000.00

-5,000.00

0.00

5,000.00

10,000.00

15,000.00

20,000.00

25,000.00

30,000.00

-6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

Year

Cumulative gain (loss) Cumulative "cash" flow

The Establishment BudgetsPerennial Crop Break-Even Calculator

Crop and locationHand Picked Blueberries,

Willamette ValleyNumber of establishment years 7Final (salvage) value of investment $0Number of full production years 25.0Interest rate for amortization 7.00Long-run full production yield 20000.00Long-run full production price $0.850

Item1st Year of Full

ProductionYear of Production Cycle (1st yr of full production = 1) -6 -5 -4 -3 -2 -1 0 1Price, % of long-run 100.00 100.00 100.00 100.00 100.00 100.00 100.00 95.88Yield, % of Full Production 0.00 0.00 0.00 20.00 40.00 60.00 70.00 100.00Gross revenue 0.00 0.00 0.00 3,400.00 6,800.00 10,200.00 11,900.00 16,300.00Non-yield-related variable costs 2,032.35 6,159.49 780.39 1,655.29 2,655.88 1,849.08 1,743.99 2,420.08Yield-related var. costs per yield unit 0.000 0.000 0.000 0.653 0.652 0.651 0.651 0.600Total of all variable costs 2,032.35 6,159.49 780.39 4,267.79 7,868.38 9,661.58 10,856.49 14,410.58Returns above variable cost -2,032.35 -6,159.49 -780.39 -867.79 -1,068.38 538.42 1,043.51 1,889.42Investments not included in var. costs or in fixed costs as depr. + interest 0.00Fixed costs for current year 509.66 702.59 679.20 773.04 764.57 764.57 764.57 781.50Current year net return -2,542.01 -6,862.08 -1,459.59 -1,640.83 -1,832.95 -226.15 278.94 1,107.92Interest carryover from prev. years 0.00 -177.94 -670.74 -819.87 -992.11 -1,189.87 -1,288.99Gain (loss) + interest carryover -2,542.01 -7,040.02 -2,130.33 -2,460.70 -2,825.06 -1,416.02 -1,010.05Cumulative gain (loss) -2,542.01 -9,582.03 -11,712.36 -14,173.06 -16,998.12 -18,414.14 -19,424.19 -19,675.96Cash flow, current year -2,542.01 -6,862.08 -1,459.59 -1,640.83 -1,832.95 -226.15 278.94 1,107.92Cumulative "cash" flow -2,542.01 -9,404.09 -10,863.68 -12,504.51 -14,337.46 -14,563.61 -14,284.67 -13,176.75Present value of cash flow -2,375.71 -5,993.61 -1,191.46 -1,251.78 -1,306.87 -150.69 173.71 644.82Summary ResultsAmortized establishment payment ($1,666.80) -1,666.80 ($1,666.80)Annual Profit in Full Production ($558.88) ($558.88)Production Cycle Profit ($13,972.01) ($13,972.01)Internal rate of return, reinv. @ IRR 4.10% Princ. part of am. pmt. $307.11Internal rate of return, reinv. @ disc. Rate 5.62% Int. part of am. pmt. $1,359.69Net Present Value -4,055.94Equivalent (Constant) Annual Payment ($320.72)Average yield in producing years 20,000.00Weighted average price in producing years 0.817

Amount to be amortized: 25 years @ 7%