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Introduction to Partial Budgeting

Many business alternatives have positive effects -- increased revenue and decreased costs -- and negative effects -- decreased revenue or increased costs. There is more than just added costs and added revenue.

As long as positive effects exceed negative effects, adopting the alternative will increase the business' profit. This method of analysis is referred to as partial budgeting. Like other short-hand methods, the budget being developed only addresses those parts of the business that will be impacted by the change. 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. The following table suggests a format for preparing a partial budget.

The bottom line or result of a partial budget projects how much the profit of the business will change if the alternative is adopted. Restated, a partial budget analysis calculates the change in profit that will result from adopting an alternative.

An alternative to a partial budget is to prepare two enterprise analyses; one for the orginal 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.

Sample Format of Partial Budget Analysis

 Alternative being considered ______________________________________________________ Prepared by _______________________________ Date prepared ___________________ Positive Impacts of Adopting the Alternative Negative Impacts of Adopting the Alternative Revenue generated by adopting the alternative \$ \$ \$ Costs of adopting the alternative \$ \$ \$ Costs saved by adopting the alternative \$ \$ \$ Revenue lost by adopting the alternative \$ \$ \$ Total Positive Impacts \$ Total Negative Impacts \$ Overall Impact (positive impacts minus negative impacts) \$___________ If the answer is greater than zero, adopting the alternative will increase the business' overall profit; if the answer is negative, the current practice is more profitable than the alternative.

Example. A soybean farmer has been using conventional tillage practices, but is considering no-till for the future. The farmer expects that the yield will decrease by 2 bushels (current market value of \$4 per bushel) if no-till is adopted. Discontinuing the conventional tillage would save \$20 per acre whereas as the increased herbicide application costs \$17. In this case, the farmer would decrease profit by \$4.91 per acre by replacing conventional tillage with herbicide.

Example of Partial Budget Analysis

 Alternative being considered: replace conventional tillage practices with no-till practices Prepared by I.M. Farmer Date prepared Feb. 200X Positive Impacts of Adopting the Alternative . Negative Impacts of Adopting the Alternative . Added revenue from adopting the alternative reduced opportunity cost \$3 at 9% for 4 months \$ .09 Costs of adopting the alternative additional pesticide \$17 Costs saved by adopting the alternative cost of eliminated tillage practices \$20 Revenue lost by adopting the alternative reduced yield of 2 bu. @ \$4/bu. \$8 Total Positive Impacts \$20.09 Total Negative Impacts \$25 Overall Impact (positive impacts minus negative impacts) \$ 4.91 If the answer is greater than zero, adopting the alternative will increase the business' overall profit; if the answer is negative, the current practice is more profitable than the alternative.

Like other short-hand methods, opportunity costs, risk exposure, and other intangible considerations should not be overlooked when using a partial budget.

• For example, if adopting the alternative would change the use of owned resources, that change in the use of owned resources needs to be recognized with a change in opportunity cost.  More specifically, if adopting the alternative would save 30 minutes of the owner's time and the owner used \$25 per hour as the opportunity cost of his or her labor, the adopting the alternative would have a positive effect of saving \$12.50 in owner's labor.

This simple table can be incorporated into a computerized spreadsheet to expedite the calculations.

This simple example does not illustrate the opportunity to include additional detail, such as the quantity of output or input, or the price per unit for the output or input.  Managers may want to add columns to the table illustrated above to provide space for these additional details.

A manager may want to develop a brief list of of inputs or outputs 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.

For some alternatives, there will no change in output; instead, the analysis becomes "what would be the change in cost."  For example, "would it be less expensive to hire a custom harvester or to buy equipment and conduct the harvesting ourselves."  In such a situation if the manager thinks the same quantity will be harvested regardless of who is doing the work, there would be no change in revenue -- only change in cost.  Accordingly when there is no change in revenue, the "bottom line" of a partial budget analysis will be "change in cost", rather than "change in profit".

Partial budget analysis determine the change in profit resulting from adopting an alternative within the business. It does not determine impact on cash flow, nor does it generally determine the change in profit resulting from a long-term investment. If these factors are critical to the management decision, a partial budget analysis must be supplemented with appropriate techniques that reveal information about impact on cash flow and the present value of future revenue and expenses.

Summary

Partial budget analysis determines the "change in profit" if an alternative is adopted. It will NOT reveal whether the original enterprise was profitable, whether the alternative enterprise is profitable, or whether the overall business is profitable.

Last Updated December 11, 2009

Email: David.Saxowsky@ndsu.edu

This material is intended for educational purposes only. It is not a substitute for competent professional advice. Seek appropriate advice for answers to your specific questions.

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