Chap12 (PowerPoint download)

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					Whole-Farm Planning
      (Chapter 12)




                      1
              Objectives
1. Explain the difference between whole-farm
   planning and planning of individual
   enterprises.
2. Learn how to develop a whole-farm budget.
3. Understand the uses for a whole-farm budget.
4. Compare the assumptions used for short-run
   and long-run planning.
5. Show how linear programming can be used to
   choose the most profitable combination of
   enterprises.

                                              2
  What is a Whole-Farm Plan
         and Budget?
• Whole-Farm Plan – An outline or
  summary of the type and volume of
  production to be carried out on the entire
  farm, and the resources needed to do it.
• Whole-Farm Budget – When the
  expected costs and returns for each part
  of the plan are organized into a detailed
  financial projection.

                                              3
  What is a Whole-Farm Plan?
• Enterprise budgets are the building blocks of a
  whole-farm plan and budget.
• Partial budgets are useful for making minor
  adjustments or fine-tuning a whole-farm plan.
• Whole-Farm Plan can be designed specifically
  for the next year or if may reflect a typical year
  over a longer time period.



                                                   4
Purpose of a Whole-Farm Plan
• Once a strategic plan has been developed the
  next step is to develop a tactical plan to carry it
  out.
• Every manager has a plan of some kind:
      • What to produce?
      • How to produce?
      • How much to produce?
• A whole-farm plan will hopefully increase
  profits or help the farm come closer to
  attaining other goals.

                                                        5
    Potential Limitations
• Compares two alternatives at a time:
  – The present plan compared with a change in the
    present plan.
• Represents a “typical” year:
  – Outcome different in non-typical years.
• Non-proportional changes in costs and revenue:
  – Economies and diseconomies of size.
• Opportunity costs:
  – Included so not same as “accounting” profit.

                                                     6
   Final Considerations
• Additional risk:
  – Is the additional average profit worth the additional
    risk or variability of profit?
  – Sensitivity analysis on revenues and costs help here?
• Additional capital requirements:
  – Is the capital available or can it be borrowed?
  – How will borrowing affect the financial structure of
    the business?
• Risk, cash flow requirements, repayment
  ability:
  – Will this additional investment cause a capital
    shortage in some other part of the business?
                                                       7
     Six Steps in Developing a
         Whole-Farm Plan
1. Review goals and specify objectives.
2. Inventory available resources.
3. Identify possible enterprises and
   technical coefficients.
4. Estimate gross margins.
5. Choose a combination of enterprises.
6. Prepare a whole-farm budget.

                                          8
                     Step 1
Review Goals and Specify Objectives
• Include both business and personal goals:
   – Profit maximization.
   – Maintaining long-term productivity of the land.
   – Maintain health of operator and workers.
   – Maintain financial independence.
   – Allowing time for leisure activities.
• Specify performance objectives:
   – Crop yields.
   – Livestock production rates.
   – Costs of production.
   – Net income.
                                                       9
                      Step 2
Inventory Resources
• The type, quality, and quantity of resources
  available determines which enterprises can be
  considered:
  –   Land
  –   Buildings
  –   Labor
  –   Machinery
  –   Capital (money)
  –   Management
  –   Other Resources (markets, transportation,
      consultants, market quotas, etc.)
                                                  10
                      Step 3
Identify Enterprises and Technical Coefficients
• The resource inventory will show which
  enterprises are possible:
   – Don’t be restricted by custom and tradition.
• Estimate the resource requirements (technical
  coefficients) per unit of each enterprise:
   – 1 acre of crops, 1 head of livestock.




                                                    11
   Identify Enterprises
and Technical Coefficients




                             12
                  Step 4
Estimate the Gross Margin per Unit
• Estimate the gross income and variable costs
  per unit for each enterprise under
  consideration:
   Gross margin = Total gross income – TVC
• Contribution toward fixed costs and profit
  after variable costs have been paid.
• In the short-run, maximizing gross margin is
  maximizing profit.

                                                 13
    Estimate the
Gross Margin per Unit




                        14
                    Step 5
Choose the Enterprise Combination
• Often determined by:
   – Personal experience and preferences.
   – Fixed investments in specialized equipment and
     facilities.
   – Regional comparative advantage.
• Can experiment with different enterprise
  combinations by developing many budgets and
  comparing them.

We will look at LP as a tool to select enterprises
 for this week’s lab!
                                                      15
                          Step 6
Prepare the Whole-Farm Budget
Uses:
  1.    To estimate the expected income, expenses, and profit for a
        given farm plan.
  2.    To estimate the cash inflows, cash outflows, and liquidity of
        a given farm plan.
  3.    To compare the effects of alternative farm plans on
        profitability, liquidity, and other considerations.
  4.    To evaluate the effects of expanding or otherwise changing
        the present farm plan.
  5.    To estimate the need for, and availability of, resources such
        as land, capital, labor, feed, or water.
  6.    To communicate the farm plan to a lender, landowner,
        partner, or stockholder.

                                                                        16
Constructing the Whole-Farm Budget
    Enterprise A                  Enterprise B              Enterprise C
   No. of units of A             No. of units of B         No. of units of C
          X                             X                         X
Gross revenue per unit        Gross revenue per unit    Gross revenue per unit
Variable costs per unit       Variable costs per unit   Variable costs per unit


                                  Whole Farm
                                 Gross revenue


                          -      Variable costs


                          =      Gross margin


                          +   Miscellaneous income


                          -        Fixed costs


                          =     Net farm income
                                                                                  17
       Sensitivity Analysis
• Analyzing how changes in key budgeting
  assumptions affect income and cost projections.
• Reduce the gross farm income by 10%:
   – Decrease in production or selling prices.
• Construct several budgets using different
  values for key prices and production rates:
   – High, average, low approach?




                                                 18
       Analyzing Liquidity
• The ability of the business to meet cash flow
  obligations as they come due.
• Include:
   –   Cash farm income.
   –   Income from nonfarm work and investments.
   –   Cash farm expenses.
   –   Cash outlays to replace capital assets.
   –   Principal payments on term debts.
   –   Nonfarm cash expenses for family living costs and
       income taxes.


                                                           19
    Analyzing Liquidity
• Profitable plans will not always have a
  positive cash flow:
  – Large interest payments in the first few
    years:
     • Analyze liquidity for the first few years of
       the plan.
     • Analyze liquidity for an average year.


                                                  20
Example of Liquidity Analysis
  for a Whole-Farm Budget




                                21
Developing a Typical Year Budget
1. Use average or long-term planning prices for
   products and inputs.
2. Use average or long-term crop yields and
   livestock production levels. Be conservative.
3. Ignore carryover inventories of crops or
   livestock, accounts payable and receivable, or
   cash balances. Assume sales are equal to
   production.


                                                22
Developing a Typical Year Budget

4. Assume that the borrowing and repayment of
   operating loans can be ignored, because they
   will offset each other in a typical year.
5. Assume that enough capital investment is
   made each year to replace assets that wear
   out.
6. Assume that the operation is neither
   increasing nor decreasing in size.

                                              23
   Short-Run vs. Long-Run
          Budgeting
Short-Run                 Long-Run
• Assume some             • Very few farms or
  resources are fixed.      ranches are profitable
                            every year.
• Assume prices, costs,
                          • A plan that involves
  and other factors are     long-term investment
  expected to hold true     and financing
  over the next             decisions should
  production period.        project a positive net
                            income in an typical
                            year.
                                                 24
   Linear Programming
• A mathematical procedure that uses a
  systematic technique to find the “best”
  possible combination of enterprises.
• Linear programming maximizes an
  objective function, subject to specified
  constraints.
• Objective: Maximize gross margin.
• Constraints: Fixed resources available.

                                             25
        Shadow Prices
• The amount by which total gross margin
  would be increased if one more unit of
  that resource were available.




                                           26
               Summary
• Whole-farm planning and the whole-farm
  budget analyze the combined profitability of all
  enterprises in the farming operation.
• Planning starts with reviewing goals, setting
  objectives, and taking an inventory of the
  resources available.
• Feasible enterprises must be identified, and
  their gross income per unit, variable costs, and
  gross margin computed.

                                                 27
              Summary
• The combination of enterprises chosen can be
  used to prepare a whole-farm budget.
• Whole-farm budgets can be based on either
  short-run or long-run planning assumptions.
• Linear programming (LP) can be used to select
  the combination of enterprises that maximizes
  gross margin without exceeding the supply of
  resources available.


                                              28

				
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