WholeFarm Planning Chapter 12

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Whole-Farm Planning(Chapter 12)
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Objectives

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

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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.

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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.

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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.

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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.

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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?

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Six Steps in Developing a Whole-Farm Plan

• Review goals and specify objectives.
• Inventory available resources.
• Identify possible enterprises and technical
  coefficients.
• Estimate gross margins.
• Choose a combination of enterprises.
• Prepare a whole-farm budget.

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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.

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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.)

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Step 3

• Identify Enterprises and Technical Coefficients
• The resource inventory will show which
  enterprises are possible
• Dont 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.

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Identify Enterprises and Technical Coefficients
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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.

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Estimate the Gross Margin per Unit
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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 weeks lab!

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Step 6

• Prepare the Whole-Farm Budget
• Uses
• To estimate the expected income, expenses, and
  profit for a given farm plan.
• To estimate the cash inflows, cash outflows, and
  liquidity of a given farm plan.
• To compare the effects of alternative farm plans
  on profitability, liquidity, and other
  considerations.
• To evaluate the effects of expanding or otherwise
  changing the present farm plan.
• To estimate the need for, and availability of,
  resources such as land, capital, labor, feed, or
  water.
• To communicate the farm plan to a lender,
  landowner, partner, or stockholder.

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Constructing the Whole-Farm Budget
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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?

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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.

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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.

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Example of Liquidity Analysis for a Whole-Farm
Budget
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Developing a Typical Year Budget

• Use average or long-term planning prices for
  products and inputs.
• Use average or long-term crop yields and
  livestock production levels. Be conservative.
• Ignore carryover inventories of crops or
  livestock, accounts payable and receivable, or
  cash balances. Assume sales are equal to
  production.

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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.

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Short-Run vs. Long-Run Budgeting

• Short-Run
• Assume some resources are fixed.
• Assume prices, costs, and other factors are
  expected to hold true over the next production
  period.

• Long-Run
• Very few farms or ranches are profitable every
  year.
• A plan that involves long-term investment and
  financing decisions should project a positive net
  income in an typical year.

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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.

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Shadow Prices

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

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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.

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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.