Partial Budgets Flashcards
What is partial budgeting?
A (rough) form of marginal analysis
–Marginal cost versus marginal benefit of a planning option
What does partial budgeting examine?
Examines effect on annual profit of a relatively minor change (i.e. incremental change) to the farm business
When is partial budgeting appropriate?
Appropriate where the option does not involve a very major change to the overall farm structure and resources
Whats the types of change in a partial budget? (4)
–Expansion of existing enterprise
–Introduction of a new enterprise or dropping a present activity
–Substitution of enterprises
–Changes in methods of production (factor substitution)
What does a Partial budget look to do?
*Looking at alternatives (screening)
Allows to plan on paper before doing it on farm level- is it actually a good idea?
What are the different style formats for partial budgeting?
-Account style format
-Report style format
(Account style is the one we will use to complete in exam)
You could be given a full partial budget in an exam and asked to give your assumptions for the budget or you could be given a smaller question and you might be told assumptions aren’t required- in this case you are expected to do the calculations but not to give the assumptions
What are the different types of Partial Budget costs?
(3)
Extra Additional costs (Incremental Cost)
Costs Saved (Escapable Costs)
Sunk Costs
Whats a Sunk costs?
Already incurred and it cant be recovered, its no longer an escapable costs
They often drive farmers to stay farming a particular enterprise
E.g. the specialized pig unit- you’ve spend the money, and you can’t recoup that money.
Dep is going to be an expense incurred every year until its written off in our accounts.
What costs are we looking at in a partial budget?
Extra/additional costs (Incremental costs)
What is an extra/additional costs (Incremental costs)?
–Additional/extra costs incurred as a result of the decision being taken
–Costs associated with an incremental increase in size of an activity/enterprise or addition of a new activity/enterprise* E.g. increase sow herd from 50 –60 sows => extra costs of concentrates, vet/med., etc
What is a cost saved (escapable cost) ?
–Costs saved as a result of the decision being taken
–Costs saved by reducing the size or exiting an existing enterprise/activity on the farm
- E.g. reduce beef herd by 15 head => costs saved from less concentrates, fertiliser, veterinary, etc
List the 2 revenues in partial budgets?
-Extra/ additional Revenue
-Revenue Foregone
Extra/additional revenue in a Partial Budget- what is it?
–Incremental revenue as a result of taking a decision
–Incremental revenue from added or expanded activity
* E.g. increase tillage enterprise => extra revenue from sales of more grain and straw
Revenuue Foregone in a Partial Budget- what is it?
–Revenue foregone or lost as a result of the decision being taken
–The revenue that will be lost from the reduction or exit of an existing activity on the farm* E.g. decrease beef enterprise => revenue foregone from sales of beef cattle
What are the Steps to prepare a Partial Budget? (6)
1.Carefully define the option/plan to be budgeted
2.Extra/additional revenue
3.Revenue foregone
4.Costs saved
5.Extra/additional costs
6.Calculate the expected increase (or reduction) in annual farm profit
What does a partial budget capture?
A partial budget captures the expected change in annual farm profit after the change/option/decision has been fully implemented
–It may also be necessary to evaluate the impact on profit and especially on cash flow during the implementation period (e.g. where a plan is implemented over a number of years
Budgeting for changes in fixed costs:
What are the 3 major aspects?
a)Costs associated with fixed capital investment– New buildings or machinery
b)Interest costs on investments in working capital
c)Labour costs
Whats the depreciation in partial budgets?
Straight line
Opportunity Cost
The cost of money that’s tied up (in buildings, machine etc) theres a cost associated with this
Proper definition : the return from the best alternative use of that capital
An interest rate used depends on the opportunity costs
What is free capital ?
Capital available to invest
Rate of return for next best alternative use
Know how to determine the interest rate/opportunity cost rate (MCQ Question)
Budget cost associated with investment in a fixed asset =
Depreciation + Interest on Average Capital Invested
What is working capital in a partial budget?
(Livestock, variable inputs)
–Budget should include an interest charge on the average capital invested to account for opportunity cost of this capital
–Investment in variable inputs accumulates over the production horizon
–Average capital tied up in livestock and variable inputs such as feed, is related to the length of time periodthat it’s tied up (i.e.on average how much money is committed until point of sale when the investment can be recouped)
What is the interest rate for fixed costs?
As for fixed assets, interest rate depends on circumstances (i.e.opp. cost)
–Borrowing on overdraft
– overdraft rate
–Free capital
– rate of return on next best alternative use
–Capital savings
– savings rate
Working capital for breeding stock :
Capital invested calculation
Investment in Breeding livestock (e.g. dairy cows, suckler cows, ewes, sows)
–Capital is tied up continuously as long as enterprise is operated
–Capital invested = (average price per head) x (number of he
What the rules for working capital?
** The costs must be apportioned in the budget according to the period (proportion of year) that capital will be tied up
(i.e. must work out average annual cos
For trading livestock what is the calculation?
Capital invested =
Capital invested = (Average purchase price per head) x (number of head) x (P/365)
Where P = the lesser of the time period in days between sale of each batch OR length of production period in days from start to sale (in many cases both will be the same but not always)
What is trading livestock?
Investment in Trading livestock (store cattle, pigs for fattening, etc)
–Assume capital is recouped when animals are sold
When is trading livestock capital investment different?
Except where a continuous batch system i.e. immediate purchase of another batch after sale of previous with more than one batch per year (e.g. pig finishing, broiler production), then: Capital invested = (Average purchase price per head) x (number of head per batch
What are variable costs ?
How do you calculate the investment in inputs until point of first sale?
-variable costs (inputs)– both crop and livestock enterprises
–Input costs will be recouped from product sales–Calculate investment in inputs until point of first sale–(variable input cost per unit) x (number of units) x (P/365) x (1/2)
Where P = the lesser of the time period in days between sale of each batch OR length of production period in days from start to sale
Note: Many beef enterprises are systems with annual sales so (P/365) = 365/365 = 1A dairy enterprise has monthly sales so (P/365) = (30/365) = 1/12
What does Preparing a budget clarify?
Clarifies issues surrounding a decision
What’s the Advantages of Partial Budgeting?(MCQ) (7)
*Exploring possible changes to the farm
–New enterprises
–New methods/techniques etc. e.g.. More/less intensive
-Expansion
*Identifying most rewarding alternatives
–Use a number of partial budgets
*Clear benefits of application
–E.g. to obtain bank loan for an investment
*Partial budget act as blueprint/roadmap
– useful planning tool
–What you expect will happen
–Compare actual with budget
*Relatively simple approach
–Less opportunity for error
*Process of preparing budget is a useful discipline
–Informed decision making
*Sensitivity analysis
–Can use budget to check how sensitivity of the estimated outcome with respect to changes in key assumption
What is a limitation of partial budgeting? MCQ (5)
*Does not focus on the overall demand for resources
*Can be a hit and miss approach
–Can encourage narrow thinking
–Subjective bias of planner
*Evaluates the profitability of a project but not the cash flow (feasibility)
*Sometimes used in a “slack” way
*Danger of overlooking certain costs (e.g. fixed costs)
Parial Budgeting can come up as a calculation style question , it could be a really long question or it could be a short question.
You might be asked to include assumptions , you might be asked to ignore assumptions and just do the calculations.
It can also come up as a theory question: you might be asked advantages/ disadvantages
Or what information goes into a partial budget
