Chapter 12: Kay and Edwards Whole-Farm Planning Chapter 12: Kay and Edwards

Agenda Whole Farm Plan Whole Farm Budget Linear Programming Simplified Linear Programming

Whole-Farm Plan It is a summary of the intended kinds and size of enterprises to be carried on by farm business. A whole-farm budget can be derived from a whole farm plan by applying expected cost and returns for each part of the plan into a detailed projection.

Whole-Farm Plan Cont. This plan can be very detailed and include fertilizer, seed, and chemical application rates and actual feed ration for livestock. This plan can also be very simple and list only the enterprises to be carried out and their desired levels of production.

Whole-Farm Plan Cont. A whole-farm plan and its associated budget can be built upon enterprise budgets and partial budgets. Differing whole-farm plans can be compared for their profitability, feasibility, risk exposure, and financial position.

Steps in Developing a Whole-Farm Plan Review goals and specify objectives Take an inventory of the physical, financial, and human resources available Identify possible enterprises in their technical coefficients Estimate gross margins for each enterprise

Steps in Developing a Whole-Farm Plan Cont. Choose a plan— the feasible enterprise combination that best meets the specified goals Develop a whole-farm budget that projects the profit potential and resource needs of the plan

Review Goals and Specify Objectives Management goals that can affect a whole-farm plan: Profit maximization Maintaining the long-term productivity of the land Protecting the environment Guarding the health of the operator and workers Maintaining financial independents Allowing time for leisure activities

Review Goals and Specify Objectives Cont. Given a set of goals, the manager should be able to specify a set of performance objectives: Crop yields Livestock production rates Cost of production Net income

Inventory Resources The type, quantity, and quality of the following resources should be inventoried: Land Buildings Labor Machinery Capital Management Other resources

Identify the Technical Coefficients of Each Enterprise A budgeting unit should be defined for each enterprise. The resource requirements per unit of each enterprise, or the technical coefficients, must be estimated. These technical coefficients determine the maximum size of the enterprise and the final enterprise combination.

Identify the Technical Coefficients Cont. Enterprise budgets can help organize this information. Example for an acre of corn: 1 acre of land 4 hours of labor 3.5 hours a tractor time $135 of operating capital

Estimate the Gross Margin Per Unit Gross margin per unit is the difference between total gross income and total variable costs. It is the enterprise's contribution toward fixed costs and profit after the variable costs have been paid.

Estimate the Gross Margin Per Unit Cont. Calculating gross margins requires the manager's best estimates of yield or output for each enterprise, and expected selling price. Calculating variable costs requires identifying each variable input needed, the amount required, and its purchase price.

Choosing the Enterprises Within a farmer's whole-farm plan, many enterprises have been pre-determined by personal experience and preferences, or fixed investments in specialized equipment and facilities. For this group of farmers the whole-farm plan is directed to creating a whole farm budget.

Choosing the Enterprises Cont. Some farmers use a whole farm plan to experiment with different enterprise combinations by developing a series of budgets and comparing them.

Purposes of a Whole-Farm Budget 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.

Purposes of a Whole-Farm Budget Cont. 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, livestock feed, or irrigation water. To communicate the farm plan to a lender, landowner, partner, or stockholder.

Procedures for Developing a Typical Year Budget Use average or long-term planning prices for products and inputs, not prices that are expected for the next production cycle. Use average or long-term crop yields and livestock production levels.

Procedures for Developing a Typical Year Budget Cont. Ignore carryover inventories of crops and livestock, accounts payable and receivable, or cash balances when estimating income, expenses, and cash flows. Assume that the borrowing and repayment of operating loans can be ignored when projecting cash flows in a typical year, because they will offset each other.

Procedures for Developing a Typical Year Budget Cont. Assume that enough capital investment is made each year to at least maintain depreciable assets at their current level; i.e., to replace those that wear out. Assume that the operation is neither increasing nor decreasing in size.

Two major Tools for Whole Farm-Planning Sensitivity Analysis Linear Programming

Sensitivity Analysis A procedure for assessing the riskiness of a decision by using several possible price and/or production outcomes to budget the results, and then comparing them. Example: fluctuate production price or yield by +/- 10%

Linear Programming It is a mathematical procedure that uses a systematic technique to find the best possible combination of enterprises. Linear programming is usually best done on a computer. Microsoft Excel has a program that does linear programming under the heading called Solver.

Information Needed for Linear Programming Resource inventory Potential crop and livestock enterprises Technical coefficients or the resource requirements per unit of each enterprise Gross margins

Components of a Linear Program The objective function It is the goal of the farm laid out as a mathematical function, which is either maximized or minimized. Decision variables These are related to all the items you have the ability to change, e.g., land allocation, labor allocation, water allocation

Components of a Linear Program Cont. The constraints (binding or non-binding) The constraint lays out the level of each resource available and how each enterprise uses each resource. A binding constraint is a constraint that is met with equality, i.e., all of the resource in question is completely used. A non-binding constraint is a constraint that is met with inequality, i.e., all of the resource in question is not completely used.

Setting-up a Linear Programming Problem Using a Spreadsheet You need to set-up a table where each column represents a decision variable The first row in the table should have the objective coefficients in terms of each decision variable The next set of rows should have the constraints with coefficients that correspond to the decision variable

Setting-up a Linear Programming Problem Using a Spreadsheet Cont. The last row should be used for the decision variables The third to last column in the table should have equations that represent the usage of the resources

Setting-up a Linear Programming Problem Using a Spreadsheet Cont. The second to last column should give the relationship between the constraint equation and the actual level of the constraint, e.g., <=, >=, =, etc. In the first row, the equation gives the objective value The last equation should have the actual constraint value which should be a number

Example of Linear Programming Table Corn (C) Soybean (S) Gross Margin 3 6 3C+6S Water Constraint 2.5 4 2.5C+4S <= 1000 Land Constraint 1 1C+1S 200 Machinery Constraint 2.2 1.8 2.2C+1.8S 400

Solving Linear Programming Problems Using a Spreadsheet Excel has an add-in called Solver that can solve linear programming problems. Major components to Solver are: Set Objective: To: By Changing Variable Cells: Subject to the Constraints: Make Unconstrained Variables Non-negative should be checked Select a Solving Method:

Simplified Linear Programming A simplified programming process abstracts from the linear programming method to estimate the solution to a linear programming problem. There are six steps.

Steps to Simplified Linear Programming Calculate the maximum units of each enterprise permitted by each resource that is limited in supply. Identify the smallest of these limits for each enterprise. This is the maximum amount that can be allocated to the particular variable.

Steps to Simplified Linear Programming Cont. Multiply the gross margin per unit by the maximum amount of production for each enterprise. Select the enterprise that has the greatest gross total margin,introducing it in the plan up to the maximum that can be used.

Steps to Simplified Linear Programming Cont. Calculate the quantity of each resource that is still unused. Repeat the previous steps until all resources are exhausted, or there is not enough resources to continue with a next enterprise.

Simplified Linear Programming Versus Linear Programming Simplified linear programming is much easier and can be done with pencil and paper, but it is only an approximation of the maximum amount. While normal linear programming is more accurate, it usually requires the use of a computer.

Example of a Linear Programming Problem Suppose you have two enterprises, corn and soybeans, that use three resources--land, labor, and operating capital. You know that you have 120 acres of land, 500 hours of labor, and $30,000 in operating capital. To do an acre of corn, you need 1 acre of land, 5 hours of labor, and $200 in capital.

Example of a Linear Programming Problem Cont. To do an acre of soybeans, you need 1 acre of land, 3 hours of labor, and $160 in capital. The gross margin on an acre of corn is $120, while the gross margin on an acre of soybeans is $96.

Mathematical Representation of the Problem Let x = an acre of corn Let y = an acre of soybeans Max. 120*x + 96*y w.r.t. x,y Subject to: x + y  120 5*x + 3*y  500 200*x + 160*y  30,000

Mathematical Representation of the Problem Cont. Solution methods will be discussed and worked out in class using: A linear programming approach. A simplified linear programming approach.