July 9, 1997

Partial budgeting

Dr. Vern Pierce
University of Missouri Commercial Agriculture
CLICK HERE to download a partial budget spreadsheet.

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Planning includes taking an inventory of resources, devising alternate uses of these resources, and choosing the best alternative. By employing budgeting principles, a manager can compare costs and returns of alternative plans of action for a farm business. Ideally, a manager should be able to choose a course of action that most nearly matches long-range goals.

Partial budgets are useful to evaluate changes such as:

Partial budgeting is based on the principle that a small change in the organization of a farm business will have one or more of the following effects.

  1. Cause additional returns to be received
  2. Eliminate or reduce some costs
  3. Cause additional costs to be incurred
  4. . Eliminate or reduce some returns
The net effect will be the sum of positive economic effects minus the sum of negative economic effects.

Components of the Partial Budget

The seven components of the partial budget are additional returns, reduced costs, additional costs, reduced returns, totals of the first two and the second two, and a net difference. When constructing a partial budget think about how THE CHANGE will affect each category. For example, additional returns are those returns that occur if the change takes place. Reduced costs are those costs that are lower under the proposed change. Additional costs are those that are only incurred if the change is implemented. Finally, reduced returns is that income that would no longer be received if the change is initiated. The difference between positive and negative economic effects is an estimate of the net effect of taking the proposed change.

A positive difference indicates the potential increase in net returns if the change is made. Conversely, a negative difference is an estimate of the reduction in net returns if the change is adopted. The extent of the positive or negative difference, given the managers confidence in the numbers used, impacts the final decision made.

Mechanics of Partial Budgeting

When the reasonable alternate plans are identified, the most important step begins. The success of the partial budget depends on prediction accuracy, which depends on the accuracy of the information and estimates it contains. The manager needs to collect factual data about the proposed change and provide reasonable estimates of such items as future prices, yields and gains. Factual information includes current costs of the factors of production, costs of capital, current commodity prices, or other items pertinent to the particular decision.

It is difficult to generate estimates for future unknowns, particularly prices. The manager must estimate yields and prices to get an idea of what returns will or will not be received. Yield and production estimates can be obtained from several sources. The best source is individual production records that show the historical production level. This, combined with an assessment of current crop conditions, should closely predict future yields, given normal weather and other conditions.

Future product prices are more difficult to predict. Agricultural economists, USDA statisticians, and futures markets provide information about the trend of prices, national crop and range conditions and national production estimates. However, it will be unusual to find a predicted price for a product on a particular day. Using information published by the above sources, and a manager's intuition, will provide a good estimate of future prices for products.

Perhaps a more revealing approach is to use a range of prices (low, medium and high) to evaluate changes. This method will evaluate the price sensitivity of the projected change. The partial budget is ready to be developed after all pertinent data is assembled. The amount of dollar cost that will result from making the proposed change is calculated for each of the categories. Again, only the costs and returns that change by proceeding with the alternate plan should be included in the partial budget. The unit used to analyze the change may be any size (depending on the change): the whole crop, one acre of the crop, one head of cattle or the entire herd. After the analysis is performed, the result should be multiplied as necessary to show the economic impact on the entire enterprise or business. The column totals show, respectively, the negative and positive economic aspects of the proposed change. Subtract the first column total from the second column total to obtain a net amount that reflects the change in net income if the proposed alternative is adopted.

A note of caution: the value of the analysis using partial budgeting is only as accurate as the input data. A positive net change says it would be economically wise to proceed with the alternate plan. A negative amount implies that it would not be economically profitable to proceed with the change. Other factors to consider when making the final decision are:

Partial Budget Template

Column 1 Amount Column 2 Amount Additional returns Additional cost
* * * * * * * * * * 1. Total additional 3. Total additional returns cost Reduced costs Reduced returns
* * * * * * * * * * 2. Total reduced 4. Total reduced costs returns
5. Total Positive 6. Total negative benefits benefits (line 1 + line 2) $ (line 3 + line 4) $
Net Change in Income (line 5 - Line 6)
Written by Dr. Vern Pierce-Beef Economist, 573-882-8229

A Microsoft Excel Spreadsheet of the partial budget template is available for downloading at the following address, http://agebb.missouri.edu/download/university/partbudg.xls. If you have any questions regarding downloading this spreadsheet please contact the AgEBB office at 573-882-4827 or e-mail.

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