Farm Management Lecture 2 PDF

FARM Management BASIC MANAGEMENT CONCEPTS  Productive Resources Resources are often called factors of production. These are traditionally and conveniently classified into four main groups; 1. Natural resources, 2. Labour, 3. Capital and 4. Management ...

FARM Management BASIC MANAGEMENT CONCEPTS  Productive Resources Resources are often called factors of production. These are traditionally and conveniently classified into four main groups; 1. Natural resources, 2. Labour, 3. Capital and 4. Management  Natural Resources Definition Gifts of nature that are not the result of human effort; e.g. Land Water Minerals Vegetation  Land Definition Land is the original indestructible properties of the soil. Types In terms of ownership: Stool land /Community land/ Gov’t land/private land; In terms of usage or suitability for farming: Agric. land/ non-agric land; In terms of habitability/dryness: Dry land/Wet land Mode of Land: Customary; outright purchase, Acquisition/source leasehold, inheritance, gift Units of In acres or hectares. An acre of land is about Measurement the size of a standard football field, and one hectare is about two and a half times that size  Labour Definition The effort of human beings. It is the group of productive services provided by human physical effort, skill & mental power Types 1. Family, hired/ exchange labour/ nnoboa/communal; or 2. Skilled/unskilled Mode of Relations/family/co-farmers/hiring/community Acquisition/source Units of Man-hours, or man-days Measurement (No. of workers X No. of hrs or days worked X Rate of working) Reward Wage  Labour (Cont’d) A man-day is the amount of labour provided by an average man in a working day, and depends on the number of workers, the number of days worked and their rates of working. Rates of working depends on sex, age, health of workers, nutrition, the task (nature of work), plot size, the tools and methods used, etc.  Labour (Cont’d) Men may cultivate or weed faster but harvest more slowly than women. Women tend to specialize in crop harvesting, processing and marketing, and care of small livestock. Children help with planting, weeding, and harvesting For these reasons some system of weighting has to be used to convert hours worked by women and children to man-hour equivalents  Calculation of Man Days Category of No. of No. of Rate of Man-Days workers workers Days Working worked Adult males 2 8 1 16 Adult females 3 6 0.75 13.5 Children 6 4 0.5 12 (under 15yrs) Total man-days - - - 41.5 Source: Onumah et al. (2018)  Capital Definition Stocks of goods or assets (resources) produced from past human effort and have not yet been consumed but are still available to be used in production to earn future income. Types Durable and consumable or fixed and current assets (or long-term and short-term assets); Examples of Fixed Assets: buildings, roads, machinery & and tools, permanent tree crops, Examples of Current Assets: fertilizer, pesticides, seeds, cash. Mode of Borrowed, own savings, outside equity (i.e. Acquisition/source contribution from past owners), grant/gift Units of Physical quantities, value terms, cubic capacity Measurement  The Circular-Flow Diagram MARKETS Revenue FOR Spending GOODS AND SERVICES Goods Firms sell Goods and and services Households buy services sold bought FIRMS HOUSEHOLDS Produce and sell Buy and consume goods and services goods and services Hire and use factors Own and sell factors of production of production Factors of MARKETS Labor, land, production FOR and capital FACTORS OF PRODUCTION Wages, rent, Households sell Income and profit Firms buy = Flow of inputs and outputs = Flow of dollars Copyright © 2004 South-Western  Mgts: Variable and Common Costs There are two main types of cost involved in the production process of the farm. I. Variable costs, and II. Common costs I. Variable costs are all costs that vary (or change) in direct proportion to the level of activity; for example: to the area planted, the number of livestock or the volume of output. Besides varying in proportion to activity level, a variable cost must be specific to a certain enterprise (i.e. it must not be shared among enterprises).  Variable and Common Costs Variable costs are usually avoidable if the enterprise is dropped or discontinued, and they can be controlled directly. Examples: cost of feed, seed, fertilizer, chemicals, specific casual labour, etc. II. Common costs are usually called “fixed” costs, though some vary in the long term.  Common Costs In practice, common costs are all costs that cannot be classified as variable either because: they do not vary (or change) in direct proportion to small changes in the level of activity in the short run, or they cannot be allocated to a single enterprise or both. They tend to be unavoidable in the short run and, therefore, cannot be controlled directly. While variable costs affect short-term decision- making, common costs usually affect long-term decision-making.  Common Costs Examples of common costs: - machinery and building costs, - overheads such as salaries of permanent staff, administrative expenses, bank charges, rents, general insurance. Some costs contain both variable and constant elements e.g. irrigation water, electricity and telephone costs. Depreciation due to age or obsolescence is a “fixed” cost whereas that due to wear and tear varies with use. Water, electricity, and telephone costs often include a fixed minimum charge, rent, and a charge that varies with use.  Gross Margin Analysis Gross margin is the surplus which remains after variable costs have been deducted from the value of production or gross income. i.e. Gross margin = Gross income - Variable costs Construction of gross margin (1 Ha maize) Gross Income GHS Sale of maize: 8 bags @ GHS50.00 each 400 Home consumption: 2 bags @ GHS50.00 each 100 Increase in value of stock: 1 bag 50 Gross income per Ha 550  Gross Margin Analysis (cont’d) Variable Costs Labour: 40 man-days @ GHS3.00 per man-day 120 Seed: 20 kg @ GHS4.00 per kg 80 Fertilizer: 2 bags @ GHS75.00 per bag 150 Chemicals: (62.5% of seed cost) 50 Total variable cost 400 Total Gross margin per Ha 150 Gross margin per man-day 3.75 Gross margin per cedi variable cost 0.38 Gross margin may be defined for each enterprise and for the whole farm.  Gross Margin Analysis (cont’d) When the gross margin is defined for each enterprise, such as maize or groundnut, it is referred to as Enterprise Gross Margin (EGM) When defined for the whole farm, such as maize and groundnut, it is known as Whole Farm Gross Margin (WFGM) The EGM is the value of total production of an enterprise less the total variable costs of the enterprise EGM = Gross income of enterprise – Variable costs of enterprise WFGM is the sum of enterprise gross margins  Gross Margin Analysis (cont’d) Maize (GHS) Groundnut (GHS) Gross Income 550 720 Fertilizer 150 50 Chemicals 50 50 Labour 120 180 Seed 80 100 Total variable cost 400 380 Man-days 40 60 GM per Ha 150 340 GM per man-day 3.75 5.67 GM per cedi variable cost 0.38 0.89 Enterprise Gross Margin per Ha of maize is GHS150 Enterprise Gross Margin per Ha of groundnut is GHS340 Whole Farm Gross Margin (2 Ha) is (GHS150 + GHS340) = GHS490  Strengths and Weaknesses of Gross Margin System Strengths 1. It is a simple method of assessing efficiency of both human and material resources. 2. It eliminates the problem of allocating common costs to single enterprises on the same farm to be compared. 3. It enables farm planning to be carried out relatively easily.  Strengths and Weaknesses of Gross Margin (cont’d) Weaknesses 1. It does not produce a profit figure but provides a useful figure for comparing enterprises from farm to farm, or year to year on the same farm so long as the figures are compared on a like-for-like basis. 2. It does not take account of overhead costs, and since enterprises create different levels of overhead costs, it can be misleading to compare enterprises on a farm purely on gross margins; e.g. Consider two identical rice farms, A and B, one using own labour and tractor and the other using casual labour and hired tractor services:  Strengths and Weaknesses of Gross Margin (cont’d) Farm A uses own labour and tractor, thus these costs will be shown in the farm common costs and will not appear in the enterprise gross margin. Farm B uses casual labour and hired tractor services – thus these costs will be shown as variable costs in the enterprise gross margin. The GM for A will be higher than for Farm B but performance may not be different. 3. Profit is not proportional to gross margin; -increasing the intensity of enterprises on a farm may increase the whole farm gross margin but not necessarily the farm profit because the overhead costs may have risen faster.  Net Farm Income Net farm income is sometimes called net income or net profit. Net Farm Income = Whole Farm Gross Margin - Common Costs  Net Farm Income (cont’d) If whole farm gross margin is smaller than common costs, a net loss will occur resulting in reduction of capital employed in the business. The alternative ways of increasing net farm income or reducing losses are: 1. reduction of common costs 2. reduction of enterprise variable costs 3. raising whole farm gross margin by more than any rise in common costs through increased level of activity  MARGINAL ANALYSIS A very small change (rise or fall) in the total amount of a variable is referred to as a marginal change. Hence marginal analysis examines the relationship between very small changes in related economic variables, such as changes in total physical production, total revenue or total costs in relation to unit changes in input or output. The common marginal values are: marginal physical product (MPP), marginal value product (MVP), marginal factor cost (MFC), marginal revenue (MR), and marginal cost (MC).  Marginal Analysis (cont’d) Marginal physical product (MPP) refers to the addition to total physical product (or output) when an input is increased by one unit. ie. e.g. Suppose an increase in fertilizer from 100 kg to 105 kg increases maize output from 1000 kg to 1200 kg per acre. The addition to output due to 5 kilograms addition to input is 200 kilograms. Therefore MPP = 200/ 5 = 40 kg.  Marginal Analysis (cont’d) Marginal value product (MVP) is the addition to total revenue (or value of production) due to one unit addition of an input. ie. where Pq is the unit price of output Marginal factor cost (MFC) is the cost per unit of added input. It is also referred to as the marginal unit cost.  Marginal Analysis (cont’d) Marginal revenue (MR) is the addition to total revenue when output is increased by one unit. ie. Marginal cost (MC) refers to the additional cost necessary to produce one more unit of output. ie.  Marginal Analysis (cont’d) Marginal analysis is the basic approach used in production economics to determine the optimum level of production, which conventionally occurs at the point where marginal value product (MVP) equals marginal factor cost (MFC) As long as the addition to revenue (value of production) exceeds the cost of input added, the producer would continue to add input until the addition to revenue is equal to cost. i.e. MVP = MFC = ? Px  Marginal Analysis (cont’d) Computation of MPP, MVP and MFC Input (X) Output (Q) ∆Q ∆X MPP MVP MFC (in bags) (in mini bags) Pq = GHS10 per mini bag Px = GHS40 0 3 1 15 12 1 12 120 40 2 25 10 1 10 100 40 3 30 5 1 5 50 40 4* 34* 4 1 4 40 40 5 37 3 1 3 30 40  Marginal Analysis (cont’d) In the above example MVP = MFC at the point where 4 bags of input yield an output of 34 minibags. Alternatively, the optimum level of production occurs at the point where marginal revenue (MR) equals marginal cost (MC) i.e. MR = MC  Marginal Analysis (cont’d) Computation of MR and MC Input (X) Output (Q) TC TR ∆Q ∆TR ∆TC MR MC Profit in bags in mini bags 0 3 0 30 30 1 15 40 150 12 120 40 10 3.3 110 2 25 80 250 10 100 40 10 4.0 170 3 30 120 300 5 50 40 10 8.0 180 4* 34* 160 340 4 40 40 10 10.0 180 5 37 200 370 3 30 40 10 13.3 170  Enterprise Profitability Profitability of an enterprise may be estimated using two approaches: 1. Marginal costing or variable costing, and 2. Full cost accounting or absorption costing 1. Gross income (GI) – Variable Costs (VC) = Enterprise Gross margin (EGM) = Contribution to Common Costs 2. GI – VC – Share of Common costs = Enterprise profit The first estimation process is based on variable costs (i.e. costs which would change with a change in the level of output or activity) and ignores common costs. E.g. the area cropped or number of livestock kept.  Marginal Costing (Cont’d) In the marginal costing approach the concept of profit is regarded as the contribution of an enterprise towards to recovery of the common costs (or the difference between total income and total variable costs). This approach aims at maximizing the total contribution from available resources; and useful in decision making.  Marginal Costing (Cont’d) Example of Marginal Costing Milk Maize Cotton Total (GHS) (GHS) (GHS) (GHS) Gross Income 300 300 170 770 Material costs 180 130 70 380 Labour costs 70 80 10 160 Total variable costs 250 210 80 540 Contribution 50 90 90 230 Common costs - - - 180 Profit - - - 50 Marginal costing ignores allocation of common costs to enterprises and shows that milk is contributing towards the recovery of the common cost even though the contribution is smaller than that from maize and cotton.  Marginal Costing (Cont’d) Maize has the same gross income as milk but provides almost twice the contribution. Cotton has less gross income than maize but provides the same contribution. This also shows clearly that turnover alone does not determine profit. Thus marginal costing aims at maximizing total contribution from the available resources.  Marginal Costing (Cont’d) Assume the common cost of GHS180 have been allocated to enterprises in proportion to their gross outputs. The share of the common cost is GHS70, GHS70 and GHS40, respectively for milk, maize and cotton; and enterprise profit estimated as follows:  Absorption Costing Absorption costing is the second approach. It is also referred to as full cost accounting or cost accounting. It uses both variable and common costs for the estimation of enterprise profit. In conventional absorption costing, profit is regarded as the difference between total income and total cost. The aim is to find the average cost of production and profitability.  Absorption Costing (Cont’d) Example of Absorption Costing Milk Maize Cotton Total (GHS) (GHS) (GHS) (GHS) Gross Income 300 300 170 770 Material costs 180 130 70 380 Labour costs 70 80 10 160 Total variable costs 250 210 80 540 Common costs 70 70 40 180 Total costs 320 280 120 720 Profit (Loss) (20) 20 50 50 The milk enterprise shows a net loss of GHS20 and suggests that whole farm profit could be raised merely by dropping milk production.  Absorption Costing (Cont’d) However, dropping milk production would reduce total profit because the common costs allocated to milk would remain (refer to Table below). Effect of Discontinuing Milk Production Milk Maize Cotton Total (GHS) (GHS) (GHS) (GHS) Gross Income - 300 170 470 Material costs - 130 70 200 Labour costs - 80 10 90 Total variable costs - 210 80 290 Common costs - 115 65 180 Total costs - 325 150 470 Profit (Loss) (25) 15 (10) As shown in the table, total profit could fall from GHS50 to a net loss of GHS 10; and the implication now is that maize production should also be dropped.  Absorption Costing (Cont’d) Absorption costing is misleading sometimes but should be analysed with care, whilst noting allocation to common costs. Enterprises may seem to be unprofitable when in fact they are contributing to overall profit. Common costs should be regarded as an indivisible lump while variable costs may be allocated to separate enterprises. This is the basis for marginal costing which is useful in practical management.  Reading Assignment Depreciation Valuation Definition Types Limitations Depreciation Three Methods of Depreciation