Enterprise Budgeting

Management is a process in which information is the input and decisions are the output. Budgets provide information for farm management decisions. Budgets can be constructed to estimate what you think will happen in the future. These projected budgets are used to make decisions regarding changes in the farm plan by predicting the consequences of envisioned changes.

Budget estimates also can be used as a criterion against which to measure actual performance. At the end of the year, an actual budget or historic budget should be constructed and compared to the projected budget. By comparing the two budgets, the farm manager can see which income or expense items were overestimated or underestimated. This comparison provides information for the manager to improve future decisions.

Types of Budgets

There are four basic types of farm budgets: whole-farm, cash-flow, partial, and enterprise. All budgets include income and expenses from the farm operation. The income sources and expense items included in the budget determine the budget type.

Whole-Farm. A whole-farm budget includes all income and expenses for a single year fora given farm plan. Therefore, a whole-farm budget can be prepared only after the whole-farm plan has been developed. This requires taking inventory of the farm resources and bringing farm financial statements up to date.

Whole-farm budgets usually include both cash and noncash income and expenses. Cash income includes cash received for farm products, custom work, and Government payments. Noncash income includes pasture for grazing owned livestock and wheat straw. Cash expenditures are paid for with cash within the time period of the budget. They include principal and interest payments on loans. Noncash expenses are incurred when farm resources are utilized without cash payment. Typical noncash expenses include unpaid operator and family labor; unpaid operator management; and equipment, buildings, and land owned outright by the farm business. (See Part III, Chapter 7 on whole farm budgeting.)

Cash-Flow. A cash-flow budget includes only cash receipts and cash expenditures. A cash-flow budget is usually constructed on a monthly basis for 1 year to show the timing of the receipts and payments and the monthly cash surpluses or deficits. A cash-flow budget may include the cash receipts and expenditures for the whole farm or for an individual enterprise.

Partial. A partial budget estimates the expected changes in income and expenses when a change in the whole-farm plan is incurred. It typically compares two alternative enterprises or two alternative production practices for the same enterprise. Only the increases and decreases in income and expenses expected from the proposed change are included. This simplifies the analysis of the proposed change. Both cash and noncash expenses are included in a partial budget. (See Part III, Chapter 6 on partial budgeting.)

Enterprise. An enterprise budget, the focus of this chapter, contains all of the income and expenses associated with a single enterprise including direct and indirect expenses. Direct expenses are those that are directly associated with a specific enterprise. An example is seed for alfalfa. Indirect expenses are those costs that are associated with more than one enterprise. An example is the cost of insurance on farm equipment. Direct expenses are relatively easy to estimate. Indirect expenses, however, must be allocated to all associated enterprises. There are several allocation methods that are typically used. Each has its strengths and weaknesses. (Allocation methods are discussed in the next section of this chapter.)

The term "enterprise budget" is used to refer to both projections and summaries of costs and returns. Projections of annual costs and returns for an enterprise are called enterprise budgets, but they are also known as gross margin calculations, projected budgets, or pro forma budgets. Summaries of costs and returns for an historic period may also be called enterprise budgets, but they are often referred to as cost of production studies, income and expense budgets, enterprise statements, or enterprise accounts.

Historic records are essential to developing projected budgets.

Developing an Enterprise Budget

The first step in developing an enterprise budget is to identify the enterprises on the farm. An enterprise is generally defined as a crop or type of livestock produced for profit. However, many growers identify each field or orchard block as a separate enterprise.

A farm might have two alfalfa enterprises and three walnut enterprises rather than one enterprise for each crop. By subdividing the same commodity into several enterprises, the farmer can monitor crop performance on a field-by-field basis and pinpoint problems as they occur. However, increasing the number of enterprise budgets also increases bookkeeping detail.

Many farmers who develop separate budgets for each field find that the differences are not significant enough to warrant the required paperwork. However, other farmers who develop one budget for each commodity find that the information generated is not detailed enough to make certain production decisions. Experiment with the two methods to see which generates the information you need.

In general, enterprise budgets are constructed from whole-farm records by allocating the income and expense items for the whole farm to individual enterprises. From an accounting perspective, this can be done at the end of the year or during the year as the transactions take place. The latter has the advantage of increased accuracy.

The cash journal which includes the cash receipts and expenditures for the year is the most critical farm record for developing enterprise budgets.

The best approach to budgeting combines enterprise and whole-farm budgets. Record direct expenses and income to enterprises as the transactions occur and charge indirect expenses to whole-farm accounts. Then, at the end of the year, allocate the indirect expenses charged to the whole-farm account to the enterprises. This requires setting up income and expense accounts for each enterprise or using supplemental worksheets to develop the enterprise budgets.

Income. Assigning income received from the sale of farm products to the appropriate enterprise is usually straightforward. However, when cash is received this year for last year's enterprise and cash receipts for this year's enterprise are delayed until next year or later, assigning income can be problematic. Often, the exact amount of income to be received from a sale is not known with certainty at the time the product is sold.

Care should be taken to credit the correct enterprise and to include income for one production year so that it can be compared to the expenses for the same enterprise for the same production year. In some cases, this means estimating part of the expected income. The budget can always be revised when more information becomes available.

Expenses. The major categories of expenses included in an enterprise budget are labor, materials, machinery, overhead, and investment. The income statement for the farm as a whole includes totals for each of these categories. The total from each of these categories is allocated to the farm enterprises. In practice, the allocation process may be different for each expense category.

Labor. Labor records are a means for computing wages, as well as allocating labor costs to enterprises and to cultural operations within enterprises. Time cards should be filled out daily and should detail the time spent in each enterprise. The equipment used should be recorded at the same time.

The information on time cards should reveal the total number of labor hours to be directly allocated to each enterprise. The appropriate hourly rate must include wages plus worker's compensation and Social Security insurance. In addition, the value of any noncash benefits such as housing or a pickup truck should be assigned a value for the year, divided by the total number of hours, and included in the hourly labor rate.

Labor expenses such as road maintenance, sick leave with pay, and paid vacations cannot be directly charged to an enterprise. These should be added up, divided by the total number of labor hours, and added to the labor rate at the end of the year.

Materials. Quite often a bill will be for materials applied to several enterprises. At the time the bill is received, the allocation to each enterprise can be written right on the bill. The expenses can then be recorded in the appropriate enterprise expense accounts. This method works well for fertilizer and pesticides.

On an irrigated farm, water is charged to each enterprise according to use. The cost of obtaining and delivering the water should be included in the total expenses. Irrigation labor is charged to each enterprise as labor and should not be included in the cost of water. Quite often the amount of water applied to each enterprise is not known with certainty and must be estimated.

Machinery. Machinery operating costs include fuel, lubrication, and repairs; ownership costs include depreciation, interest, taxes, insurance, and housing. It is not possible to allocate each of these expenses separately as they occur. Instead, the total cost of the machinery is calculated and then charged to the individual enterprises at cost. On paper, the farm is renting the machinery to (and from) itself and breaking even on the venture.

A list of hourly rates should be developed for each truck and tractor and other self-propelled machinery. The hourly rates are developed so that the total of the hourly charges will equal the total of all costs for farm machinery. It is not necessary to develop a list of rates for each implement. The expenses associated with implements can be spread over the tractor rates and, thus, simplify bookkeeping.

Overhead. Overhead includes management, property taxes, fire insurance, road maintenance, accountants' fees, legal fees, telephone, clerical costs, and other office costs. These costs are difficult to allocate to enterprises and are often incorrectly omitted from enterprise budgets. Misallocation and omission mask the true profit picture. These expenses should be recorded for the farm as a whole and then allocated at the end of the year.

Allocating indirect expenses is probably the most difficult aspect of developing enterprise budgets it is certainly the most highly contested. However, consistency among budgets is ultimately what is most important. Consistency allows budgets to be compared and budget calculations to be explained. Share of gross income, share of direct costs, and share of total acreage are the most commonly used methods to allocate indirect expenses.