Agribusiness Library LESSON L060024: DEVELOPING AND ANALYZING BUDGETS

Objectives 1. Describe the importance of budgeting to the financial health of a business. 2. Distinguish between fixed and variable costs, and identify examples of fixed and variable expenses when running a business. 3. Demonstrate the ability to develop and analyze whole business budgets.

Objectives 4. Demonstrate the ability to develop and analyze enterprise and partial budgets, and define opportunity costs. 5. Explain the relationships between enterprises.

Terms Budget Competitive enterprise Complimentary enterprise Fixed costs Opportunity cost Partial budget Supplementary enterprise Variable costs Whole business budget

 A budget is a plan for a business that lists the expected income and expenses for a given time period.  The purpose of a budget is to determine if the business has the potential to be profitable.  Budgeting is important for the financial health of a business for several reasons, including:  A. It is necessary to plan ahead for financial needs throughout the year in relation to cash flow.

 B. It is necessary to stay within a budget to avoid insurmountable debt.  C. It is necessary to allocate resources to the most urgent business needs.  D. It is necessary to manage the business with available financial resources.

 Different classifications of costs are associated with a business.  A. Fixed costs are costs that do not change as the level of production increases or decreases.  These expenses will be incurred regardless of business production.  Fixed costs are associated with items such as depreciation, interest, repairs, taxes, and insurance.

 B. Variable costs are costs that increase as the level of production increases and decrease as the level of production decreases.  These are operating costs such as feed, seed, fertilizer, chemicals, and any other materials necessary to produce a product.

 A whole business budget is a budget that looks at all components of the business.  A. There are numerous reasons to budget.  1. A budget is a plan for meeting financial obligations.  2. A budget is useful when applying for credit.  3. A budget allows an individual to experiment with opportunities to show alternative outcomes before investing resources.  4. A budget enables an individual to organize the business.

 B. Collecting reliable data for budgets is critical.  The following data sources should be used.  1. Actual business records  2. State summary data  3. Sample data  4. Data from similar businesses  5. Computer sources

 C. Whole business budgeting has limitations.  1. It is difficult to predict future actions (e.g., cost and price).  2. There is a tendency to underestimate expenses and overestimate income.  3. Budgeting is time consuming.

 A partial budget is a financial form that shows the expenses and income related to a possible change in the business/enterprise.  A. Examples of changes that may require a partial budget include:  1. Expanding an enterprise  2. Adding an alternative enterprise  3. Changing production practices  4. Purchasing new equipment

 B. A partial budget will answer the following four questions:  1. What additional returns will be received?  2. What costs will be reduced?  3. What additional costs will be incurred?  4. What returns will be lost?

 C. Opportunity cost is the cost or value lost if using the next alternative purpose for a product.  Examples of opportunity costs include:  1. Planting soybeans instead of corn in a particular field in a year when soybeans prices rise and corn prices remain steady  2. Using a building to rent storage space to one person instead of dividing up the area to rent storage to multiple people

 Businesses have relationships with other businesses in an economic society.  Additionally, one individual business can show economic relationships with the enterprises within the business.  There are three main types of relationships between businesses and enterprises.

 A. A supplementary enterprise is a relationship where resources are moved from one enterprise to another; this results in an increase of one enterprise without affecting the output of the other enterprise.  Examples of a supplementary enterprise include:  1. Using grain fields after harvest for cattle pasture area  2. Landowners leasing the right to hunt on property

 B. A complimentary enterprise is a relationship where resources are used from one enterprise to complement or enhance another enterprise; this results in an increased output for both enterprises.  Examples of a complimentary enterprise include:  1. Owning an apple orchard and selling half of the apples to a wholesaler and using the other half as a pick-your-own business  2. Owning a lawn mowing business and using the mower to remove snow in the winter months (if it is the proper type of machine)

 C. A competitive enterprise is a relationship where two enterprises are competing for the same available resource and that particular resource cannot be shared.  Examples of a competitive enterprise include:  1. Corn and soybeans competing for the same acre of land  2. A livestock facility that can be used for cattle, sheep, or goat production

REVIEW What is the importance of budgeting to the financial health of a business? What is the difference between fixed and variable costs, and what are some examples of fixed and variable expenses when running a business?

REVIEW How can whole business budgets be developed and analyzed? How can enterprise and partial budgets be developed and analyzed? What are opportunity costs? What are the different kinds of relationships between enterprises?