Creating an Enterprise Budget

An enterprise budget is a planning tool that helps you estimate revenue, expenses, and net returns, typically on an annual basis. The first four case studies discuss key points when creating enterprise budgets for different kinds of enterprises: a cow-calf operation, hay production, beef, and a diverse crop rotation. Case Study 5 illustrates some of the important considerations when creating an annual enterprise budget for a perennial system, including how to account for one-time establishment costs and variable yields over the life of the crop. Each case study includes completed budgets in spreadsheet form. 

The information in an enterprise budget is presented as follows:

• Revenue: The first section of an enterprise budget includes details of expected income, or revenue, from the enterprise. In our case studies, we calculate revenue as expected yield multiplied by expected price per unit of production. Sometimes you’ll have more than one source of revenue for an enterprise, such as both weaned calves and culled cows (see the the cow-calf budget example in Case Study 1). In a perennial system, like the strawberry production example, revenue may change over time, so you’ll need a system to capture this (see Case Study 5).
• Expenses: In the next section, list your expenses by category, starting with variable costs, such as seed, fertilizer and fuel. Also called operating costs, these expenses are closely tied to production levels, and can increase or decrease accordingly. Fixed costs, also called ownership costs, are listed after the operating expenses. Fixed costs are necessary for production but don’t typically change along with your level of production. They include items such as machinery depreciation, land rent and interest on the capital invested in your operation. Since these expenses can be complicated, you may want to calculate them separately and simply summarize them in the enterprise budget. For more on this, see the next section, “Estimating Your Fixed Costs,” as well as the case studies. 
• Net Returns: The last section of an enterprise budget determines profitability, or net returns, by subtracting expenses from revenue. Dividing total expenses by your yield will calculate a breakeven price, or the selling price where total income equals expenses at a given level of production. Similarly, dividing total expenses by your selling price will calculate a breakeven yield, or the yield level at which total income is equal to expenses at a given selling price. You can perform even more analyses by using different price and yield assumptions to illustrate profitable production at different selling prices and yield levels. In addition, you can determine breakeven price and yield information separately for variable and fixed costs.

The advantages of using a spreadsheet are obvious, as you can easily update information as you change your projections. You can start with a spreadsheet template and change it to suit your needs. If you have a multi-year system like grassfed beef production (see Case Study 3), a multi-year rotation (see Case Study 4), or a perennial crop (see Case Study 5), calculating net returns will be a bit more complex.

Economic Budgets Versus Cash Budgets

You can create an enterprise budget as either an economic budget or a cash budget. An economic budget determines the profitability of an enterprise, and includes non-cash expenses such as depreciation. A cash budget uses actual cash expenditures and income only. Both have their place in farm management. A cash budget may not account for specific contributions made by the farm’s assets over time. For example, you probably don’t pay yourself an hourly wage for all the hours you spend on the farm, and so the value of your labor isn’t reflected in a cash budget. 

On the other hand, an accurate economic budget will tell you if a particular enterprise is a profitable use of your assets, including your land, labor and capital, because fair market values for all these items are included. If you aren’t earning enough on an annual basis to cover both your variable and annualized fixed costs for a particular enterprise, your operation isn’t sustainable in the long run.

Economic budgets include opportunity costs as part of the total cost estimate. An opportunity cost estimates the income you could receive by employing an asset in its next best use. For example, if you know the rental value of farmland in your area, your opportunity cost for choosing to farm it yourself would be the rental income it could generate. The reason for including opportunity costs is that if you weren’t farming, you could do something else with your limited resources of labor, land, and capital. The purpose of economic analyses is to prioritize the use of your assets based on your specific goals. Finally, including opportunity costs gives you a more accurate and complete estimate of profitability. 

A personalized set of enterprise budgets should include all the variables you’re interested in. Your goal should be to estimate whether farm revenue covers all the expenses associated with the enterprise, including overhead items like accounting and utilities. In addition, you may want your enterprise to help pay for specific objectives, such as a retirement fund or health insurance premiums. 

Estimating Your Fixed Costs

Too often, fixed costs are ignored in the planning process. They’re difficult to calculate because they involve estimating the annual value of long-term assets. For example, estimating the years-of-life and salvage values for all your vehicles and machinery is often a best guess. Also, you tend to take on new fixed costs infrequently, such as when you buy more land or machinery. However, these expenses are very large, and poor choices in this area may make the difference between success and failure of the entire farm operation. On the plus side, fixed costs tend to stay relatively consistent from year to year, unless you make changes to your long-term assets, such as equipment and facilities.

Case Studies 1 and 4 demonstrate how an enterprise can look profitable when we only account for the variable costs, but unprofitable when we include its fixed costs. 

The total amount of your fixed costs is the sum of the annualized costs associated with all the long-term assets you use for the enterprise in question, such as land, machinery, vehicles, buildings, and other equipment. In an enterprise budget spreadsheet, you may want to list the details of your fixed costs on a separate sheet. As an example, see Fixed Cost Worksheet, Cow-Calf Enterprise Budget, Western Washington, 50-Head in Case Study 1. This spreadsheet includes specific details about the bulls; buildings, improvements, and equipment; machinery and vehicles; and the retained livestock investment. Specific estimates of years of life, the salvage value, and the discount or interest rate are provided and used to estimate economic depreciation and capital costs. 

Estimating the Economic Value of Land

Using your actual land rent, or the current market rate for land rent, are obvious ways to estimate the economic value of your land in an enterprise budget. Two other methods involve using the potential profitability from farm production to represent the land’s value, or using the real estate value of the land.

Case Study 4, the Palouse grain farm, uses a traditional land rent agreement called cost-sharing. This is one example of using the farm production method to estimate the land’s value. The landlord receives one-third of the crop and pays one-third of the fertilizer cost. This value fluctuates with profitability levels, creating a risk-sharing approach to land cost in this semi-arid area where crop failures are common.

To use the land’s real estate value as a proxy for rent, you simply multiply a desired annual return on investment, typically 4–6% for farmland (but potentially much higher in some markets with development pressure), by the current land market value. For example, if the land is currently worth $3,000 per acre and you desire a 5% return on investment, the annual land rent would be $150 per acre, or:

In Case Studies 1, 2, and 3, land rent isn’t included in the costs of production. Producers are encouraged to use a value that is specific to their own operation. When land costs are excluded from an enterprise budget, then the net returns include a residual for land. For example, net returns to land and management means that your profit doesn’t include any charges for land or management. 

Machinery, Buildings, Equipment, Vehicles, and Breeding Stock

Depending on your enterprise, you may be able to estimate fixed costs for machinery together with other multi-year investments in the straightforward manner described here and used in Case Study 1. Annual economic depreciation is estimated by subtracting an estimate of the equipment’s salvage value (its value at the end of its useful life) from its current market value, divided by years of life (an estimate of how long you’ll continue to use it), or: 

Annual capital costs are estimated as the average value of your capital investment multiplied by an interest rate of your choosing. (See the box “Choosing an Interest Rate for Planning Purposes.”) In this usage, annual capital costs are a proxy for your desired return on the capital you have invested in your operation—basically, they represent an opportunity cost for your capital. The average capital investment is calculated by dividing the sum of the current market value and the estimated salvage value by 2. The equation for capital costs is: 

Most producers have a list of vehicles and equipment for tax depreciation purposes. In this publication, we calculate the annualized fixed costs of these multiyear investments using the two equations above. Note that you would depreciate purchased livestock, but not breeding stock. The appropriate annualized fixed cost for raised breeding stock (retained livestock) is calculated by multiplying the total market value of all your breeding stock by an appropriate interest rate.

We do this in the budget spreadsheet in Case Study 1. The breeding livestock are listed in the second sheet, Fixed Cost Worksheet, Cow-Calf Enterprise Budget, Western Washington, 50-Head, and then the total value is linked to the first sheet, Cow-Calf Enterprise Budget, Western Washington, 50-Head, where it’s multiplied by 6%.

Estimating Your Farm Machinery Operating Expenses

Machinery costs are highly variable by farm. They can also be one of your largest expenses. In order to simplify the complicated task of estimating machinery costs, some enterprise budgets use typical custom rates for each machinery operation. However, current custom rates aren’t always available—or even relevant for your operation—and the more relevant your information, the better your cost estimates will be. Also, it’s important to estimate your largest costs accurately, such as repair costs. 

In the following example, we can calculate the fixed costs for a grain truck used during harvest as follows, using the formulas described in the previous section:

• Current market value (your estimate of what you could sell it for right now): $15,000
• Years of life (How many more years do you think you’ll use it?): 12
• Salvage value (your estimate of what you can sell it for in 12 years): $5,000
• Interest rate (or desired return on capital invested in machinery): 5%

Annual economic depreciation would be ($15,000 - $5,000) ÷ 12 or $833 per year. This is the value of your asset that you’re using up each year, given your estimates. Your annual interest or capital expense would be ($15,000 + $5,000) ÷ 2 x 0.05 or $500 per year.

It’s impossible to know with certainty the actual lifetime costs of each piece of machinery until the end of its useful life, but you can easily update and refine these estimates over time. Machinery costs can be substantial, and therefore it’s important to account for them in some way when determining profitability. Estimating machinery costs by crop can help with critical decisions such as whether you can afford to upgrade a piece of machinery. In Case Study 2 we look at the tradeoffs involved in replacing a baler using a partial budget analysis.

Based on the information you record for your farm-related machinery and vehicles (see Table 2), you can use a machinery cost calculator (see Resources) to estimate both variable and fixed costs for farm machinery. We use this approach in Case Study 2 (hay production) and Case Study 4 (grain production). You can then summarize the actual annualized machinery costs for each piece of machinery and include it in your enterprise budgets by cost category (e.g., fuel, labor, depreciation, etc.).

Commonly used programs to estimate annual machinery costs are available in the Resources section. 

An Example of Capturing Machinery Costs

For an example of capturing machinery costs, see the Machinery Costs per Acre sheet we use in Case Study 2, a hay production enterprise. The first table in that sheet lists all machinery operations by cost category. Then, additional tables are used to calculate machinery costs for each specific enterprise based on this information. In the second table in that sheet, machinery costs are determined by listing each machinery operation associated with round bale production, and a third table determines the machinery costs associated with small square bale production.

The total machinery costs by category (e.g., depreciation, interest, etc.) are then populated in the appropriate areas of the enterprise budget. The Round Bale Budget sheet displays Fixed Costs in the lower portion of the table.A machinery depreciation line pulls in the figure calculated in the Machinery Costs sheet, which is $10.70 per acre. Similar costs are provided for machinery interest ($14.34) and machinery insurance, taxes, housing and licenses ($4.93)categories. These totals from the Machinery Costs sheet are also populated in the appropriate lines of the Small Square Bale Budget sheet for that enterprise. We use a similar approach to machinery costs in Case Study 4, a crop rotation of winter wheat, spring barley, chemical fallow, and spring canola. See the Machinery Costs sheet and the budget sheets for each phase of the rotation.