Partial budgets provide quick help in decision-making

Some decisions are easier to make than others. Some decisions take more time than others. Not sure why but people will sometimes take more time to make a $1,000 decision than a $100,000 decision.

I recently had two interesting discussions with farmers. One was with a farmer who has been presented with an opportunity to buy a piece of land. The other was with three farmers who are wondering about merging their farm operations.

The land purchase situation needed a decision soon. It was completely unexpected and not something that had been budgeted or planned for. The challenge in this situation was the timing of the decision-making process. The opportunity came up just as the family was busy with harvest, when time is valuable and scarce.

The merger opportunity decision wasn’t as imminent. Time, though, was still a consideration with the question being how much time to commit to a complex decision, in a situation where farms potentially involved in the merger have busy operations and not an abundance of available time for the decision-making process.

Each situation, though, required that a decision be made. Good management practices would indicate that comprehensive planning processes be applied. Those include analysis of the opportunities and how they fit into long-term strategies. Complete operating plans and an approach to marketing and human resource management would be included.

Detailed financial analysis would include proforma balance sheets, income statements and monthly statements of cash flow, and applicable capital budgets — all relevant information to have when making decisions on the opportunities. But the analysis required a considerable amount of time and effort. And what if, after all that planning activity, the financial outcomes don’t justify the investment and associated risk?

Partial budgets

There is another approach to the planning process that can be used. Partial budgets are simple management processes that help organize and analyze many of these types of decisions.

A partial budget helps farm owners/managers evaluate the financial effect of incremental changes. A partial budget only includes resources that will be changed. It does not consider the resources in the business that are left unchanged. It only considers the impact on net farm income of the revenue and expenses that will be changed, and any capital and financing required. That makes it a great tool to use anytime during the year because it does not require that the entire farm budget be re-worked. It is a quick and relatively easy way to analyze even a complex situation.

A first step is to write a clear statement of the change or opportunity being considered. The purpose of the statement is to ensure that all relevant and applicable aspects associated with the situation have been included.

Let’s look at an example. A farmer is considering buying a new larger combine to replace two, older units because he is facing a labour challenge. Note that the statement includes both the change itself and the reason that the change may make sense. The next step is to list and analyze the likely positive and negative financial impacts of the change.

Partial budgeting principles

Partial budgets are based on the principle that business changes have effects in one or more of the following areas.

  • increases in income
  • reductions or elimination of income
  • increases in costs
  • reductions or elimination of costs
  • increases in capital and financing
  • decreases in capital and financing

The net impact of the above effects will be the positive financial changes minus the negative financial changes. A positive net indicates that farm income will increase due to the change or opportunity, while a negative net indicates the change will reduce farm income.

If the partial budget exercise indicates that there are good financial outcomes associated with an opportunity or change, it would then make sense to invest the time necessary to complete the comprehensive planning approach.

If the partial budget indicates that the financial outcomes are not acceptable, then no further time needs to be invested in the decision-making process.

Terry Betker, P.Ag, is a farm management consultant based in Winnipeg. He can be reached at 204-782-8200 or terry.betker@backswath.com.

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