The current market, with rising input prices and potential downward pressure on output prices, is stressful. Given the “squeeze” your farm might be experiencing, and to predict profitability, take a step back and evaluate your projected costs and revenues.

To help with the process, there are tools, such as enterprise budgets, available through Michigan State University Extension, to help with the process.

How do enterprise budgets help?

Enterprise budgets help to make simple and strategic farm management decisions. On the simple decision front, you could project fertilizer costs will be higher in the coming year, so you can look for ways to reduce cost or explore other cost-reduction. As another example, suppose after creating the enterprise budget, you determine you have a high equipment depreciation and decide to sell an underutilized tractor.

This process includes evaluating the profitability of each farm enterprise. Are we producing the proper mix of products or should we be doing something different?

Regardless of your commodity mix, understanding how profitable enterprises are can help you to answer tough questions and make the best decision for your farm.

Enterprise budgets alsoare useful in forward-contracting and hedging decisions. Using enterprise budgets may help you determine if prices offered will return a profit or a loss.

Basic structure

Revenue (including cash and non-cash revenue) usually is listed first. When reporting anticipated revenue, use futures prices (plus or less basis) or current forward-contract prices to estimate output price and use historical yield as an estimate for output quantity (total production). Include all revenue sources, such as cull cows for cow-calf and dairy, or byproduct prices like straw for wheat.

What is an example of a non-cash revenue? Assume you have a cow-calf and a backgrounding operation. Through this approach, count the calves you retain as non-cash revenue (the amount you could have sold them to someone else) for your cow-calf enterprise. The backgrounding operation would count the calves as a variable cost, which occurs only when production happens. Examples of variable costs could include fuel, feed, fertilizer, hired labor, and veterinarian costs. Recall purchased feed is valued at the purchase price, while raised feed should be valued at its opportunity cost, or the price you would have received if the feed had been sold to someone else.

Fixed costs, also known as indirect or ownership costs, must be paid even if there was no production. Examples of fixed costs include depreciation, taxes, rent or mortgage, and property and vehicle insurance. If there are multiple enterprises, consider allocating the appropriate proportion of the fixed expense to each enterprise.

Caution on profitability interpretation

Numerous enterprise budgets are available on the internet, but profit calculation may not be the same across tools. Some enterprise budgets may not account for the opportunity costs of your management, land and capital. Opportunity cost is a way to assign an economic value to resources you use for which cash may not trade hands. For example, as the farm operator, do you write yourself a paycheck?

Suppose an enterprise budget reports “returns to land and management” as profit. If so, opportunity cost for management time and land is not included in the budget. The “profit” reported is the funds left to pay for the land use and your management time. However, other budgets may include estimates for these costs and would report a more accurate (and lower, all else equal) economic profit.

Sensitivity analysis

Enterprise budgets are forecasts and rely on assumptions. Take time to test how sensitive profitability projections are to various assumptions, such as outprice, labor hours and major input expense.

MSU Extension's farm business management budgets and cost of production web page, bit.ly/3CUaMzx, contains budget tools for cow-calf, feedlot and field crops enterprises. If you need help finding a budget tool, email mckend14@msu.edu or laportej@msu.edu.

This article originally appeared on Sturgis Journal: Enterprise budgets are useful tools, especially during uncertain times