Partial Budget Analysis
- Resource: Kay, et al. Farm Management, McGraw Hill, 5th Ed. 2004, chapter 11.
- How does preparing a partial budget relate to the concept of production response?
Partial budget analysis does not determine profitability; it only determines the "change in profit" if an alternative is adopted; i.e., even though the change may enhance profit, the enterprise or overall business may still be incurring an operating loss. For example, if the business was to shift from one enterprise to another enterprise, a partial budget analysis will reveal whether the shift will increase or decrease profit. The partial budget analysis will NOT reveal whether the original enterprise was profitable, whether the alternative enterprise is profitable, or whether the overall business is profitable. The analysis will only reveal how the level of profit will change if the alternative is adopted.
- Use a partial budget to analyze the impact on profit from making a change.
- In preparing a partial budget analysis, only the parts of the business that will change if the alternative is adopted are considered in the analysis. The aspects of the business that will not be affected by the alternative are not considered because they will remain the same whether or not the change is made.
- Opportunity cost is a consideration in preparing a partial budget. If adopting the alternative changes how the manager uses his or her own assets (such as their own labor or capital), the impact of that change needs to be considered in the analysis as an opportunity cost. For example if adopting alternative production technology reduces the amount of time the manager needs to commit to the enterprise, that reduction of labor is a positive impact and must be included in the analysis as a cost saving.
- Alternatively, a manager could prepare two enterprise analyses; one for the original enterprise and one for the alternative, and then compare the profitability of each enterprise. The difference between the profitability of the two enterprises should be the same as the change in profit calculated by the partial budget analysis. Thus there is a relationship between enterprise analysis and partial budget analysis. A partial budget could be described as "a summary of the differences between two enterprise analyses of alternative activities."
- Excel spreadsheet with simple partial budget form.
- Suggestion: Use an Enterprise Analysis if the change or alternative will not impact the remainder of the business (e.g., other enterprises in the business); that is, the alternative would be a distinct enterprise in the business. Use a Partial Budget Analysis if the change or alternative will impact the remainder of the business.
- Another suggestion: Decide whether to use two enterprise analyses or a partial budget based on what information the manager wants to have when making the decision. For example, if the manager wants to know the revenue, costs and profit of each alternative, prepare two enterprise analyses. If the manager wants to know how the profit of the business will be impacted by making a change in the business, prepare a partial budget analysis.
A set of questions to help decide whether to use a partial budget analysis or an enterprise analysis.
What information does the manager need to make the decision? Restated, what is the criterion for the decision? HINT – is the manager asking which option is lower cost or which option is more profitable? Is the manager asking what is the profit for each alternative?
Now that the manager has stated the decision criterion, which analytical method provides the answer – an enterprise analysis or a partial budget analysis? HINT – what is the "bottom line" in an enterprise analysis? What is the "bottom line" of a partial budget analysis? Which one of those “bottom lines” best answers the question posed in the manager's decision criterion?
After thinking through these questions, a manager should be able explain which method to use and why.
- Suggestion: Begin the preparation of a partial budget by carefully and thoroughly explaining the change that will be analyzed. What inputs will be obviously changed ? What will be the likely change in output? Also, carefully consider the less obvious impacts of making the change. A thorough description of all changes will make the analysis easier and more accurate.
- Note the similarities between these suggestions and the discussion of a decision making process.
- In preparing a partial budget analysis, consider preparing a short list of inputs that will not be changed whether or not the alternative is adopted. Preparing this brief list of "unaffected" may help minimize the error of overlooking some aspect of the business that might be impacted by a decision about the alternative being considered.