Partial budgeting is a financial tool used to assess the costs and benefits associated with a specific change in an individual enterprise within the business operation. This tool specifically focuses on the implications of the intended change in a business operation by comparing the benefits and costs resulting from implementing the alternative with respect to the current practice.
In case of drought management, the partial budgeting technique can be used to compare the costs and benefits of an alternative operation, in this case a heifer replacement strategy, assuming different chances of the occurrence of a drought. For example if there is an 80% chance of drought, a rancher may consider the alternative of buying pregnant heifers verses raising them, in this case buying them has a $187/head advantage (see Exhibit2). However if the chance of drought is only 20%, raising heifers verses buying has an $83/head advantage (See Exhibit 1).
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Steps Involved in Partial Budgeting
1. Identifying the proposed change/s:
Before starting partial budgeting, farm managers need to be clear in their minds about why they are considering making a change and to recognize the possible alternatives to the current practice that might help them meet their desired outcome. Since partial budgeting requires some effort it is wise to choose among the best alternatives based on your initial assessment.
2. Listing the key information necessary for analysis:
This step is crucial and involves carefully gathering information pertinent to the costs and benefits associated with the proposed alternative(s). This process includes listing information about anything that would be different among the choices, things such as costs, interest, yields, time, revenue etc.
3. Identifying the positive and negative effects:
The proposed change will result in changes where some are hopefully positive effects while others will most likely be negative. The main objective of partial budgeting is to weigh positive effects of the proposed change against the negative effects of the proposed change, all relative to the current method of operation.
Positive effects of the proposed change may result because of the elimination or reduction in cost of ceasing current activities and/or the generation of additional revenues by adoption of the new activities.
The negative effects of such a change could be generated by an increase in the cost by implementing the new activity and/or a reduction in the revenue from ceasing the current activity.
For example, in the case of a livestock enterprise, where buying replacement heifers is compared to raising replacement heifers from the ranch, the positive effect could be the reduction in the cost of feeding heifers limited range resources. Other cost savings may include labor, building, equipment, and management costs. The negative effects of this proposed change could be the cost of buying cows, the inclusion of inferior genetics which results in reduced returns from the calves or anything other added cost or loss in revenue that can be attributed to buying verses raising cow replacements.
4. Estimating the Net Effect
Once the positive and negative effects are identified and quantified their difference will determine the outcome. If the proposed change has a positive net effect, the change would be considered superior to the current method and would be considered for adoption. If the proposed change has a negative net effect, the change would be considered inferior to the current method and would not be considered for adoption.
In the final analysis it is the difference between the positive and negative effects that determine how the proposed alternative(s) compares with the current method of production. It is important to note that a partial budget decision is no better than the information that goes into it. The old adage garbage in garbage out is very relevant. The table below presents a simple format of partial budgeting.
1. Reduced Costs $
2. Additional Returns $
1. Additional Costs $
2. Reduced Returns $
|Total Positive Effects $
||Total Negative Effects $
|Net Effects $