Creating a Budget

Once a year, farmer business managers must conduct an audit to ensure their financial sustainability. This audit should determine the operation’s level, progress, business efficiency, and viability. Which businesses generate the greatest profit? Which crops/animals should be raised? Should the business be expanded? Should you take out a loan and purchase a new combine harvester, or is it preferable to lease? What is the payback period? Will next year’s projected income be sufficient to cover the business’s expenses and the family’s needs? You either adhered to the cash-flow budget or deviated from it. Where have you strayed the most and why? The management can determine the farm’s production, economic, and financial performance by asking the aforementioned questions and then following up as necessary.

Budgets serve as a fundamental source of data for making farm management decisions. Budgeting involves coordinating resources, production, and expenses. A budget is a written plan for future actions, expressed in terms of physical and monetary quantities. As opposed to records, which are summaries of past outcomes, budgets are constructed to estimate the future outcomes of activities. Before committing funds or resources to an activity, budgeting enables estimates to be made on paper. This enables the company to prepare for future situations based on past events.

A budget focuses on the foreseeable future. It relies on projections, pertinent information from internal and external sources, historical data, assumptions, and experience. However, predicting all future risks and uncertainties is difficult. As a user of budgets, the farm manager must understand that budgets and the assumptions upon which they are based are subject to change at any time. Therefore, budgets should not be viewed as rigid or immovable structures, but rather as management aids or instruments. In addition, it is prudent to develop budgets based on three different scenarios: a pessimistic scenario, an optimistic scenario, and a scenario based on the expected outcomes and the probability of these outcomes.

Budgets require assumptions because information needed is not always accessible and the future is uncertain. Assumptions are necessary, but they must be reasonable, well-informed, and tested. These assumptions may pertain to yields, prices, costs, inflation, interest rates, the quality of management, and numerous other aspects of the budgeting procedure. They should be spelt out and justified in terms of the criteria or data upon which they were based.

Budgets require assumptions because information needed is not always accessible and the future is uncertain. Assumptions are necessary, but they must be reasonable, well-informed, and tested. These assumptions may pertain to yields, prices, costs, inflation, interest rates, the quality of management, and numerous other aspects of the budgeting procedure. They should be spelt out and justified in terms of the criteria or data upon which they were based.

The importance of a budget in farm decision-making cannot be overstated. A budget is an essential tool for the farm manager who confronts the business scientifically and places a high value on management and financial performance. This instrument compels the manager to intend and ensure the effective coordination of all farm activities and enterprises. A cost estimate is also a tool for exercising authority. The farmer can use the budget to determine whether the planned events are transpiring as anticipated. If not, adjustments or appropriate actions can be taken in a timely manner.

The primary purposes of a budget for a farming operation are to: Create strategic plans for the farming system and all of its subsystems;
Contrast diverse strategies;
Decide where, when, and how to invest, i.e., to determine capital needs and make investment decisions; Plan for the cash-flow position of the business in order to arrange credit at the optimal time and on the most favourable terms.

In conclusion, the purpose of creating a budget is to enable the farm business to achieve its objectives. Although a wide range of objectives are outlined, it is essential to note that the discussion that follows is predicated on the premise that maximising profits is the primary objective of a farm business.

The usefulness of a budget is highly dependent on the accuracy and realism with which the business manager estimates the quality and nature of the inputs, their costs, the expected yield (output), and the price of the output. The business manager can make more accurate forecasts by utilising his own experience, historical records, information from fellow farmers, data provided by the extension officer or bank manager, research results, etc. It is not difficult to determine the number of inputs and the associated costs, as these can typically be predicted quite accurately. The correct estimation of yields and product prices, however, is considerably more difficult. Uncertain climatic conditions have an effect on crop yields, and the resulting price fluctuations can make planning difficult. In such situations, a farm manager should utilise historical yield and price data, as well as price hedging, as guidelines. Probabilities can be utilised to estimate future price and yield. 

When calculating expected yields (and prices) for budgetary purposes, the farmer must exercise caution when utilising long-term averages. This is due to the fact that only a small number of regions in South Africa experience stable precipitation, while the majority of regions experience periodic drought. Typically, these regions are marked by an uneven distribution of precipitation. Consequently, yields (and prices) vary year to year based on rainfall or yield distribution.

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Types of budgets

There are various budgets that farmers can use, but the most common are whole-farm, partial, cash-flow budgets, as well as enterprise budgets. 

1. Enterprise budget 

During the production period, enterprise budgets project yield, costs, and returns for activities such as raising livestock, producing grain, or cultivating vegetables. Each budget specifies the production method, necessary inputs, and order of operations for the year. It also provides a summary of the associated costs and returns. Most budgets are annually based. Budgets for businesses whose production spans more than one year typically include revenue and expenditures for a representative one-year period. Budgets for businesses are essential decision-making tools. They can assist farm businesses in developing marketing plans for their production and in making other business decisions.

The level of detail, comprehensiveness, and format of a business budget may vary based on the circumstances, preferences, and objectives for its creation. Budgets for businesses should be as specific as possible. This will lead to improved and more precise planning, particularly when partial, total, capital, and cash-flow budgets are compiled. A comprehensive business budget will include the following:
Gross margin evaluation
Detailed equipment cost
An analysis of the gross margin based on parameters. 

The gross margin analysis entails estimating the enterprise’s per-hectare or per-stock-unit income and direct variable costs that are directly allocable. The enterprise’s gross margin is the difference between the gross production value and directly variable costs. It is the responsibility of the farm business manager to determine which costs can be directly allocated, as the manner in which costs are allocated varies from farm to farm. It is essential to be aware of the amount of work required and the associated expenses. There are a variety of tools available to assist farm managers in developing a comprehensive budget for machinery costs. The national department of Water, Agriculture, Forestry, and Fisheries publishes an annual guide to machinery costs as one of these resources.

The parametric or scenario analysis of the gross margin considers the impact of price and production quantity fluctuations. It reflects the different gross margins at the highest and lowest prices and yields. When preparing enterprise budgets, the month – to – month transactions flow assessment and machinery cost budgets are compiled first. The analysis of gross margin then outlines this information. A parametric analysis of the gross margin is then conducted.

 2. Partial budget

Each and every day, farm managers must make decisions. Some decisions have significant effects on the farm’s business, whereas others are less crucial. Some, such as the acquisition of a combine harvester, are infrequent. Others are made on a more frequent basis, such as deciding when to cull cows. The decision made today may have an instant impact on the farm business, or it may have a much longer duration. However, regardless of how large or far-reaching a sort of decision may be, well almost all decisions can have significant effects on the immediate and long-term achievement of the farm business.

Management could use partial budgets to assess the financial viability of a farm practise or venture that affects only a portion of the farm business. Such a budget does not necessitate a complete reorganisation of the farm business. A partial budget is utilised to evaluate the impact of a proposed change to a portion of the farm’s business on its profitability.