Using Enterprise Budgets to Make Decisions Upper Midwest Organic Using Enterprise Budgets to Make Decisions Craig Chase, Field Specialist Farm & Ag Business Management

Session Outline Why keep records? Record keeping tools Summary Enterprise budgets Partial budgets Summary Resources / Questions and Answers Note: Let’s keep this informal so if you have questions at any time – ask…

MARKETING IS…. The single most important factor in determining the profitability of the farm. “Knowing what’s happening in the marketplace is the difference between the farmer who makes it and the farmer who doesn’t make it.” Vegetable grower, Don Anderson “If you don’t have a percentage of people walking away from you at market, you are selling to cheap.” Farmer, Tim Kornder

What Does Marketing Include? Product, Pricing, Promotion and Distribution (or Placement) of products and services. A clear understanding of what consumers want and the ability to deliver it to them through the most appropriate channels for a profit.

For Today, Let’s Focus on Pricing If you have priced products before, how did you come up with your price? How much should you charge for your products? Pricing products that do not have an established market can be difficult (agree/disagree).

Pricing Produce, like many other types of products, can be priced one of three ways: Customer based Competition based Cost based

Customer Based Five strategies for setting price… 1. Support an image (e.g., organic products). 2. Increase volume (e.g., loss-leaders, coupon books, holiday baskets, etc.). 3. Range of prices to fit needs of a variety of customers Segment your market and understand the different needs for each segment. 4. Encourage volume purchases (e.g., $3/qt or $7.50/3qts). Common during peak harvest. 5. Bundle low volume products with related higher volume products. Provides incentive for customers looking for good values.

Competition Based Three primary strategies to set prices: 1. Same as the competition for similar products. If the products are unique or specialized, pricing can be set differently. 2. Lower than the competition to entice new buyers. Products may sell quickly so volume is important. 3. Maintain a percentage of the market, or market share.

Cost Based Pricing To ensure prices are being sold for a profit, costs need to be determined. Develop a budget for each enterprise that contributes substantially to the overall profitability of the business.

Pricing Summary No one pricing strategy works without the consideration of the other two. However, pricing without knowing costs to produce those products, could lead to a business failure. More buyers are looking at domestic fair trade issues. How can you determine a “fair” price? Given this trend, is knowing the cost of producing/marketing your product important?

Pricing Strategy Start with costs and then consider both the customers and the competition. If the competition will not allow a price to cover costs, then look at either differentiating the product or changing product mix. How can costs be evaluated? (answer is…) By the use of enterprise budgets…

Break for Comments Do you agree/disagree with the importance placed on marketing? Is marketing the most important aspect of your business? Do you agree/disagree with the importance placed on pricing? Where does pricing fit with respect to the other P’s of marketing? Anything else to add?

What is an Enterprise Budget? Estimate of costs and returns to produce a product. For producers who grow a large number of different products. Develop budgets for those products that contribute the most to business goals.

Enterprise Budget - Simplified Heirloom Tomatoes: Gross Revenues Less: Direct/indirect cash operating expenses Net Cash Income Less: Non-cash expenses (depreciation) Net Income Repeat for each major enterprise

Enterprise Budgets More detailed budgets typically consist of five sections: Revenue Pre-harvest Harvest Ownership (or fixed) Returns Let’s look at an example… FM 1875; PM 2017

Pricing Carrots What is the annual total cost per pound to produce carrots? What minimum price per pound is needed to cover the total cost to produce carrots? What costs are missing from the enterprise budgets? (answer is…) Transaction costs (marketing and transportation) Any questions or comments on pricing?

Other Decisions Based on Budgets Changing production practices Changing product mix Let’s look at both…

Changing Production Practices Enterprise budgets are used to track expenses and revenues. Use the budgets to calculate break-even prices and yields. Compare this number to other producers or industry standards to determine where costs are different and why. Differences in costs may indicate where changes in production practices could be made.

Changing Production Practices A second reason – track key costs. Carrot example, $54.46 (or 66%) of the total production costs is labor. Can labor be lowered without reducing yields? (i.e., can labor be more efficient?) Supplies are a small percentage (14%) of total production costs. A 10% cost reduction will not affect total production costs significantly. Don’t spend time on small items…

Production Practices Summary Changes in production practices that reduce production costs without affecting yields, can increase profitability. Without detailed records, the affect of production practices on profitability is not known. Any questions or comments on changing production practices?

Product Mix Enterprise budgets allow for a comparison of profitability and labor usage among the various crops grown. For example, carrot returns over total costs was $54.02. Labor usage was 5.35 hrs. Returns over total cost per hour was $10.10.

Returns over Total Costs Product Mix Returns over Total Costs Hours of Labor Returns over Total/Hr Asparagus $ 35.47 2.95 $ 12.02 Basil $ 164.19 6.90 $ 23.80 Carrots $ 54.02 5.35 $ 10.10 Cherry Tomatoes $ 181.11 11.20 $ 16.17 Eggplant $ 85.02 6.45 $ 13.18 Specialty Green Beans $ 140.27 18.25 $ 7.69 Garlic $ 43.89 7.15 $ 6.13 Greens $ 102.90 2.80 $ 36.75 Heirloom Tomatoes $ 547.21 $ 48.86 Potatoes $ 61.65 5.10 $ 12.09 Red Raspberries $ 131.50 6.15 $ 21.38 Snow Peas $ 58.45 7.65 $ 7.64 Strawberries $ 55.46 1.55 $ 35.78

Comparing Budgets A quick comparison of the crops in the previous slide indicates annual returns over total costs ranged from $35.47 to $547.21. Labor usage ranged from 1.55 to 18.25 hours. Returns over total costs per hour ranged from $6.13 - $48.86.

Comparing Budgets Which would you rather produce – the $6.13 or the $48.86 product? Realize that agronomic rotations, as well as the competition and customer base, do affect what and how much product is produced. However, a table outlining the differences should be developed to determine product mix.

Product Mix Summary Labor should be considered a scarce resource – limited number of hours for any farming operation. Analyze not only returns over total costs, but also returns over total costs per hour. Some products with lower returns over total costs, may have higher returns over total costs per hour because of low labor requirements.

Product Mix Summary Develop and compare enterprise budgets that significantly contribute to annual returns over total costs or labor usage (i.e., key revenue / cost concept). Labor usage comparisons are particularly important if crops are harvested at the same time.

Product Mix Summary Budgets for proposed new enterprises should be developed and compared to existing enterprises. Starting small will allow an enterprise budget to be developed and compared to determine if it should be added to the mix. Any questions or comments on product mix?

Enterprise Budget Summary An enterprise budget is an estimate of the costs and returns to produce a product and helps allocate land, labor, and capital to the appropriate use. Enterprise budgets can be used to make decisions such as pricing, changing production practices, and/or developing a product mix.

Enterprise Budget Summary Pricing is difficult and requires consideration of the customers, the competition, and costs. Start with costs and work in the other two. Compare budgets to other producers to: determine production efficiencies. analyze key expenses. determine annual returns and labor usage. For new enterprises, compare to existing enterprises to determine if it deserves to be included in the mix.

Break for Comments Do you have any questions or comments on: What goes into an enterprise budget . How one can be used for making decisions?

Other Considerations Enterprise budgets often include those costs that only occur on the farm. Therefore, transaction costs are not included and can be substantial and vary, depending upon the market being targeted.

Transaction Costs Transaction costs are costs that occur from the marketing activities of the product. Transaction costs primarily include labor and transportation costs.

Partial Budgeting Partial budgeting focuses on incremental changes in revenues and costs, which includes the following steps: State what is being analyzed. List the increases in revenues. List the reductions in costs. List the increases in costs. List the reductions in revenues. Summarize the net effects. Consider non-economic and other factors.

Partial Budgeting Graphically, partial budgeting can be represented as… Positive Impacts Negative Impacts Increased Revenue Decreased Revenue Decreased Cost Increased Cost

Transaction Costs – Example 1 You are a CSA that can deliver to two markets – a close rural (40 miles) and a long distance urban (140 miles one way). The long distance urban area was attractive because fees are $125 more for the year. 50 long distance members for a total of $6,250 more in revenue. Is this a good strategy?

Partial Budgeting Exercise What is the additional revenue? $6,250 What are the additional costs? Labor: 6 hrs @ $10/hr @ 20 wks = $1,200. Fuel: the further market incurs an additional 200 miles @ 20 mpg = 10 gallons @ $2.20 = $22.00/wk @ 20 wks = $440. Fixed: the further market incurs an additional 200 miles @ $0.10 per mile = $20 @ 20 wks = $400. Total costs: $1,200 + $440 + 400 = $2,040 Is the difference between revenue and cost positive or negative?

Transaction Costs – Example 2 You have two farmers’ markets; one close (40 miles roundtrip) and one long distance urban (140 miles round trip). You sell about 100 lbs per market and feel the further market can gross about $.40 per pound more in revenue; or $40. Is this a good strategy?

Determine Costs – Example 2 Labor The further market incurs 3 additional hrs of labor @ $10 = $30 Fuel The further market incurs an additional 100 miles @ 20 mpg = 5 gallons @ $2.20 = $11.00 Fixed The further market incurs an additional 100 miles @ $0.10 per mile = $10 Total incremental cost = approximately $50

Determine Margin –Example 2 Revenue Increase - $0.40 per pound for 100 pounds, or $40 Expense Increase - $50 per week Bottom Line: Traveling to the further market would not be more profitable. Is there a way to increase revenues? How important is this market?

Partial Budgeting – Example 2 Positive Impacts Negative Impacts Decreased Revenue N.A. Increased Revenue $40 Decreased Cost Increased Cost $50 Positive Impacts Negative Impacts Increased Revenue $40 Decreased Revenue N.A. Decreased Cost N.A. Decreased Cost N.A. Increased Cost $50 Increased Cost $50 Net Effect = -$10

Transaction Cost Summary When choosing between two alternative markets, use a partial budgeting approach. Keep in mind – partial budgeting looks only at the dollars and cents end of the decision. You need to take into consideration the other aspects of the business such as pricing, product mix, etc.

Summary How is an enterprise budget developed? What decisions can be made once an enterprise budget is developed? What are the transaction costs and how does this information help with determining which market outlet makes sense?

Thank You for This Opportunity! Questions….. Any questions or comments on enterprise and partial budgets? Thank You for This Opportunity! Craig A. Chase Farm Management Field Specialist 720 7th Avenue SW Tripoli, IA 50676 (319) 882-4275 cchase@iastate.edu