Business Management

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“Fact Sheet #545: Enterprise Budgets in Farm Management Decisionmaking”

An enterprise budget is an organized listing of your estimated gross income and costs which can be used to determine the expected net income for a particular enterprise. You calculate this type of budget on a per unit basis, such as an acre of land or head of livestock, for 1 year or one production period. This fact sheet gives you information on the use of enterprise budgets to help you estimate per unit gross income, costs, net income and break-even figures on an annual basis for crop and livestock enterprises.

The Enterprise Budget

The information in an enterprise budget can be organized in different ways, but it typically includes sections on gross income, variable costs, fixed costs and net income above selected costs.

Gross Income

Gross income consists of level of output and price per unit of output. Estimate gross income for your enterprise by multiplying the amount of output you expect by the price per unit of output. What level of output and what price per unit should you use?

Your estimated level of output (yield per acre, weight per head and others) should be based on expected input use--seed, fertilizer and the like, cultural practices, cropping sequence, soil conditions, weather conditions, feeding programs, class and type of livestock, and management level. In other words, base your estimates on what you think will happen for the planning period. Use your records, responses from neighbors, and information from Extension agents and researchers to develop an output estimate. Avoid being too optimistic or pessimistic about output estimates. It may be best to determine the estimate for next year, and then vary the output above and below this number to determine the effect of various outputs on net return. You can also calculate break-even outputs to cover variable and total costs (fixed and variable) of production that will provide you information about the minimum output needed to cover selected costs.

As with estimated output, use the best estimate of prices expected for the planning period. Prices are dependent on overall demand and supply and may vary considerably with changing conditions. Consequently, you should be in close contact with marketing and management Extension and research specialists, Extension agents, local buyers, futures markets, published price reports, outlook services and others (see Fact Sheet 544 "Marketing: Critical to Effective Farm Management"). Determine the price, and then vary it above and below the selected price to determine the effect of various prices on net return. Break-even prices also can be calculated for selected levels of output for the enterprise.

Variable Costs

Variable costs are dependent on the level of output produced. They include items such as seed, fertilizer, lime, fuel, lubricants, chemicals for weed, disease and insect control, purchased feed, veterinary services and medicine, repairs, interest on variable capital and others. To simplify cost estimates, indicate the units, quantities and prices associated with the individual expenses.

Some costs are easier to estimate than others, such as costs of seed, fertilizer and chemicals, since you know exactly how much you need and the prevailing market prices of what you need. Other costs, including labor, repairs, and machinery operating costs, depend on the size and type of machine used and are more difficult to estimate. Good sources for this information include individual farm records and data from Extension agents, neighbors and published reports from private and public sources.

Fixed Costs

Fixed costs are those costs incurred regardless of whether or not output is produced. Building and machinery fixed costs include depreciation, interest on average investment, some repairs, taxes and insurance. These costs may be difficult to estimate for your enterprise since you have to allocate the overall fixed costs to various enterprises produced on the farm. Also, fixed costs depend on conditions associated with the fixed inputs--size, type, number, new or used machinery, field operations and others.

Land is an important input and should be valued. If you own the land, charge an opportunity cost against the land since you cannot use the capital investment in an alternative endeavor. Some producers, particularly those who own their farm, do not value the land as a cost item in constructing an enterprise budget. If you do not include the land as a cost item, you will overestimate your net return. See Fact Sheet 538 "Diagnosing Your Farm's Financial Health" for a more detailed discussion on analyzing the financial health of your farm business. Generally, you would multiply the land value by the cost of capital. For example, land valued at $2,000 per acre multiplied by a 6 percent opportunity cost gives an estimated land cost of $120 per acre. Use the method that most closely represents the actual land cost to the operator.

In general, and since land values in Maryland are inflated because of the nonagricultural demand for land, multiplying the land value by the cost of capital will give a much higher estimate of value than if you were to use an agricultural rental value. For the past 5 years in Maryland, cropland rented for cash has had cash rent as a percent of value equal to 2.7, 3.3, 2.7, 2.0 and 1.8 for 1985 through 1989, respectively. These values represent cash rentals per acre that are closer to short-run opportunity costs than the land value times cost of capital. Therefore, if you are keeping the land in agriculture and not selling, use the rental rate as an estimate of the opportunity cost of capital invested in land.

Income Above Costs

Income above costs is the income remaining after covering the specified costs included in the budget. There are several incomes above costs that can be calculated. Two examples are income above variable costs and income above variable and fixed costs. Some publications list a net revenue figure without specifying which costs were subtracted from gross income. Always look behind the net figures to see what costs are included in the calculations.

The Crop Enterprise Budget

A corn enterprise budget illustrating the sections just discussed is shown in Table 1. It includes a column to insert information applicable to your farm. A blank version is included for your use as well.

Under "estimated yield," "inputs" and "prices" used in Table 1, an acre of corn will return $137.34 above variable costs and $47.34 above variable and fixed costs. These estimates represent only one set of conditions (yield, inputs, prices, others) that you, the producer, could face. Be as accurate as possible in making estimates about yields, inputs and prices.

It is beneficial to calculate the income above variable and fixed costs for various yield and price situations. This is shown at the bottom of Table 1 for four yields (75,100,125 and 150 bushels per acre) and three corn prices ($2.50, $2.75 and $3 per bushel). For low prices and yields, there is a negative net or a loss of $99.37 above variable and fixed costs. Conversely, at high yields and prices, there is a net of $148.82 per acre. The first positive net above variable and fixed costs is at a yield of 100 bushels per acre and a price of $3 per bushel.

Break-Even Yields and Prices

In many cases, you will want to calculate break-even yields and prices. Calculate the break-even yield by dividing total costs (variable plus fixed) by the expected output price. To calculate the break-even price, divide total costs (variable plus fixed) by expected yield. For example, the break-even yield for $2.75 per bushel corn in Table 1 would be $296.41 - $2.75, or 107.8 bushels per acre. For $2.50 and $3 prices per bushel, the break-even yields would be 118.6 and 98.8 bushels per acre, respectively. Compare these yield ranges to historical and expected yields to see if the analysis is reasonable for the farm.

You can also analyze break-even prices for their potential profitability. The break-even price in Table 1 for a 125-bushel yield is $2.37 per bushel ($296.41 / 125). For 75-, 100- and 150-bushel yields, the break-even price is $3.95, $2.96 and $1.98 per bushel, respectively. These figures also represent the cost of production (variable plus fixed costs). The cost of production figure is always of interest since it represents the average cost of producing a bushel at the given output level. In order to stay in business in the long run, you have to cover all costs as calculated above. In the short run, you can produce as long as variable costs are covered, or if price per unit of output is above average variable cost. Consequently, break-even yield and price values based on variable costs become important. The break-even price when you consider variable costs in the example is $206.41 / 125, or $1.65 per bushel. Therefore, if price per bushel is above $1.65 per bushel, produce the corn in the short run. The break-even price can be calculated for the other yields assumed. Also, the break-even yield at a price of $2.75 per bushel would be 75.1 bushels.

Points To Remember

When estimating break-even yields and break-even prices, remember to:

• Use your own information in developing the budget.
• Study the range in yields, prices and break-even values.
• Form your own expectations about how likely the yields and prices will exceed variable or total costs for your planning period.

The Livestock Enterprise Budget

Table 2 illustrates gross income, variable costs, fixed costs and income above selected costs per head for a beef cow-calf operation for one production period. The per head fixed costs are based on a 30-cow operation. A blank version is included for your use as well.

The livestock enterprise budget is similar in style to a crop budget but may be more difficult to estimate since livestock enterprises may have multiple outputs, must consider herd replacement, and may use some home produced feed.

Gross Income

The gross income in Table 2 is based on a 90 percent calving rate, an equal number of male (0.45) and female (0.45) calves, and a 15 percent herd replacement rate each year with raised replacement heifers. The prices are determined as for crops. With these assumptions, the sales would involve 0.45 of a 475-pound steer calf at $0.85 per pound, 0.30 (0.45 heifer calf minus 0.15 for replacement) of a 450-pound heifer calf at $0.75 per pound, and 0.15 of a 1,100-pound cull cow at $0.45 per pound. There is no receipt for a cull bull since it is purchased and no males are held back for replacement.

Variable Costs

Variable costs can include expenses for purchased and raised inputs used in the operation. Purchased items should reflect estimated cost and raised items should be valued at estimated market value. In this section, include prorated charges for repairs on fences, buildings, equipment and power, as well as hired labor. Table 2 provides a listing of the associated variable costs for the livestock operation as well as the total variable costs of $286.20 per head of livestock.

Fixed Costs

Fixed costs associated with your enterprise should include a land charge, depreciation, interest, certain repairs, taxes and insurance as appropriate for the operation. The prorated fixed costs are based on a 30-cow farming operation. The depreciation for the purchased bull represents a prorated cost of the bull over its useful life. You would depreciate replacement cows also if they were purchased. If you purchase replacement female animals, all born heifers would be sold as were true for the steer calves. Be consistent in the handling of herd replacements. Interest on livestock investment can be high because of the high capital investment in cows and the bull. Include taxes and insurance; they can be taken from farm records. Table 2 shows a fixed cost of $120.83 per head of livestock.

Income Above Selected Costs

The income above variable costs amounts to $70.99 per head. However, there is a $49.84 negative income above variable and fixed costs. As with crops, you must cover all costs to stay in business in the long run. In the short run, produce as long as variable costs are covered. This can allow you time to make changes in the operation in order to improve the long-term profitability of your business.

What about calculating break-even prices for the livestock operation? If there are multiple outputs as above, calculating these is more difficult than calculating for a single output enterprise like corn. It can be done, but it may require some trial-and-error calculations. This is true because you can obtain different break-even prices by varying the relationship between prices of steers, heifers and cull cows.

As for the corn enterprise, enter your numbers in the "Your farm" column, and see how you come out relative to a net income per animal.

Summary

This fact sheet provides information that will help producers calculate and analyze gross income, variable costs, fixed costs, net income and break-even figures for crop and livestock enterprises. The enterprise budget procedure is useful when farmers compare the relative profitability of alternative enterprises that could be produced on the farm.

Enterprise budgets for different crop and livestock activities produced on Maryland farms are available from your local Extension office. You may find these budgets helpful as you plan changes in your operation, or when you want to compare your farm numbers to cost and return figures of other operations.

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