CARLISLE, Pa. — Creating a budget can be a valuable experience not only for folks who are raising crops or livestock for profit, but also those who are homesteading. No matter the scale of your operation, knowing your costs and potential income will be valuable tools in making future decisions.
Why create an enterprise budget? Use of an enterprise budget has several benefits. One is that it enables us to create simulations to show potential scenarios and outcomes of individual enterprises. This is cheaper to do on paper with a budget than after crops are planted or animals are purchased. Doing this you can use the budget to create a roadmap for your production. Focusing and refining your production plan to identify potential hidden costs that may have otherwise been forgotten until it is too late. Use of a budget also enables you to put your plans into fileable form that you can reference later to identify the areas where you may have over or underestimated costs or income. Perhaps most importantly, utilizing an enterprise budget will enable you to know your costs of production. If you do not know your costs of production, it is impossible to know what price you need to charge for your product. Just because your neighbor is selling a product at a certain price does not guarantee that you will be profitable at the same price.
Enterprise Budgets Components
An enterprise budget can be broken into three main components. The first part is referred to as income or receipts. This part of the budget shows the products in units that will generate revenue from the enterprise such as dozens of eggs, bushels of corn, or pounds of product. In this section you will estimate the quantity of units produced and expected price per unit. It is important that these numbers are an honest estimate that is representative of 3 out of 5 years. While numbers from outlier years can be used for best/worst case scenarios, they should not be used for normal budgeting purposes as they are not average and will skew your expectations. The basic formula for this part of the budget is Income = Quantity produced x Unit price.
The second part of an enterprise budget consists of variable cost, often also referred to as operating costs. These are costs that will vary with changes in quantity of production such as feed, bedding, repairs, packaging, interest, and labor. The quantities of all these expenses are directly correlated with the scale of your production. Even if there is no hired labor it is important to consider your time and ensure that the cost of your labor is included in the budget. If you have interest expense, it is important to note that interest should be charged to the enterprise from the dates that expenses are incurred until the date that product is sold, repaying the debt. If your goal is to generate profit from your poultry, it is especially important at this point to check if your revenue is covering your operating costs. If operating costs are not covered by revenue you should look for ways to reduce costs without harming production or find a way to increase revenue. If this cannot be done you will lose money on every unit of product produced.
The third and last part of an enterprise budget is fixed costs, also called ownership costs. These costs are incurred whether production happens or not. This includes insurance, taxes, interest, buildings, and equipment. Most of these costs are incurred during the first year as establishment costs, which are depreciated over their estimated useful life for the sake of budgeting. If in the first year a small cooler is purchased to store your products in, it will likely be used for future years of production. The cost of the cooler will be depreciated over its estimated lifespan. If this is not done in the budget, it will appear that you will lose a large amount of money the first year only to be disproportionately profitable in future years. It is important to consider that if you are preparing a budget before any purchases have been made, these costs are still avoidable. It is also important to remember that fixed costs are spread evenly to units produced. While total fixed costs will not vary, the fixed costs per unit of production will decrease with volume if you are within the capacity of your facilities. If you purchase a building with the capacity of 100 birds but only house 50 birds, your fixed costs per bird will be higher than if the building was filled. However, it is important to remember that you need to have a market for your product if starting or increasing production.
Variable and Fixed costs will be added together to find your total costs. Your total costs will then be subtracted from Income to find projected profits or losses.
Completing your enterprise budget will allow you to do some analysis of the long-term viability of your production. This can be done by doing a couple break-even analysis. The first can be to check your break-even for variable costs using the following formula: Break-even = Total Variable Costs ÷ Expected Units of product. This will help you identify the price that you would need to cover just your variable costs. This is important to know because if you cannot at least cover your variable costs, you will be unable to put funds toward fixed costs such as buildings and equipment.
Using your enterprise budget, you can figure out what price you would need to break-even. The formula used for this is: Break-even price = Total Costs ÷ Expect Yield or Units. The break-even price should be equal or less than average market price if you plan to be profitable. If you have over-supply or an underdeveloped market for your product you will be unable to cover your costs of production on anything that you are forced to sell under this price.
You will also be able to find your break-even yield or units of production needed to break-even at expected sale prices. This can be done using: Break-even Yield = Total costs ÷ Sale price. This can be helpful if you are adjusting costs for items that will improve or reduce production. Using this formula will help you to see if cost adjustments will result in a realistic break-even yield. This formula is also used to find how many units of production is needed to generate enough profit to cover your fixed costs.
Things to Keep in Mind
An enterprise budget does not necessarily account for the costs of management and the risks associated with your enterprise. It is also important to consider opportunity costs; what would your return be for your time and money if it were invested somewhere else. Also, an enterprise budget should be created for every product produced on your farm. For example, if you are raising corn and soybeans to feed your poultry separate budgets should be created for corn, soybeans, and the poultry. These budgets can be combined to create a whole farm budget.
An enterprise budget is only as good as the numbers that are used. in it. For it to be an accurate tool it is important that values used are realistic and achievable. However, you can change numbers to create best-and worst-case scenarios for your enterprise to see how you will fare if everything goes wrong or if everything is perfect. Often reality will be somewhere in the middle, so it is beneficial to have a plan for both. It is also important to remember that an enterprise budget can be a valuable source of economic information but is not a substitute for good management of production and proper planning to market your products.
–Russell Phenicie, Penn State Extension, Franklin County