AGEC 311

AGEC 311
FARM MANAGEMENT
Course Instructor: D. P. K. Amegashie
Office Location: Rm 8 Conference Building

Agric Econ & Agribusiness
Office Hrs: Mondays –Thursdays 2:30 – 4:30p.m.

COURSE OUTLINE
• 1. INTRODUCTION
• The Field of Management
• Objectives of Farm Management
• Management Decision Making
• Farm Planning
• Farm Control
• Areas to be Managed
• The Need for Business Management in Farming
• Factors Affecting Managerial Effectiveness
COURSE OUTLINE (CONT’D)
2. BASIC MANAGEMENT CONCEPTS

• Productive Resources
• Variable and Common Costs
• Gross Margin Analysis
• Net Farm Income
• Marginal Analysis
• Marginal Costing
• Valuation and Depreciation
3. FARM MANAGEMENT INFORMATION
• What is Management Information?
• The Need for Management Information
• Sources of Information
• Records: Objectives of Records and
Accounting
• Physical Records
• Financial Records
• 4. PREPARATION OF FINANCIAL
ACCOUNTS
• Profit and Loss Statement
• Balance Sheet
• Sources and Uses of Funds Statement
• 5. ANALYSIS OF FINANCIAL ACCOUNTS

• Analysing Profit & Loss Statement
- Comparative Whole Farm Analysis
- Management and Investment Income (MII)
- Sources of Variation in the MII
- Analysis of Outputs and Costs
• Analysing the Balance Sheet
- Ratio Analysis
- Solvency
- Liquidity
- Stability
- Flexibility
• 6. MANAGEMENT ACCOUNTS
• Full Cost Accounts
- Allocation of Costs
- Advantages of Full Cost Accounting
* Gross Margin Accounts

- Preparing Gross Margin
- Uses of Gross Margin Accounts
COURSE OUTLINE
(CONT’D)
7. FARM BUDGETS
• Purpose of Budgets
• Types of Budgets
• Constructing Budgets
8. CONTROL
• What is Control?
• The Need for Control
• Financial Control
• Operational Control
• Budgetary Control
• 9. RISK AND UNCERTAINTY

Plagiarism
• The University has a policy on ‘plagiarism’.
• Plagiarism is ‘the presentation of the work or idea of

another in such a way as to give others the impression that it
is the work or idea of the presenter. Adequate attribution is
required. What is essential is that readers must not have any
doubt as to which words or research results are yours, and
which are drawn from other sources’.
• In other words avoid taking credit for something that is not

yours. Also avoid copying from other students as much as
possible, because these have serious implications for your
studentship.
Assessment and Grading:
• Continuous Assessment = 30%

• Examination = 70%
• Total = 100%
• Note: There may be at least one unannounced

quiz in the course of the semester and form part
of the continuous assessment mark.
Letter Mark Grade Interpretation
Grade (%) Point
A 80 - 100 4.00 Outstanding
B+ 75 - 79 3.5 Very Good
B 70 - 74 3.0 Good
C+ 65 - 69 2.5 Fairly
C 60 - 64 2.0 Average
D+ 55 - 59 1.5 Below Average
D 50 - 54 1.0 Marginal Pass
E 45 - 49 0.5 Unsatisfactory
F 0 - 44 0 Fail
COURSE OUTLINE
(CONT’D)
• Reference Texts:
• Barnard, C.S. and Nix (1976) Farm Planning and Control
• Johnson D. T. (1982): The Business of Farming
• Robert O’Connor (1973): Principles of Farm Business
Analysis and Management
• Upton Martin (1978): Farm Management in Africa
• Anaman K. A. (1988): African Farm Management
The Field of Management
• Management is the active process of making decisions for the planning and
control of the use of available human and material resources of an
organisation to achieve its specific objective(s) most efficiently.
• Management begins with setting objectives, which are the strategic plans of
the business.
• Decisions must be made later to develop tactical plans, execute (or implement)
them and exercise control as far as possible over events.
• Managers exercise their planning and controlling functions in four

identifiable areas, namely: production, finance, personnel and marketing.
• The field of management can be represented in a diagram as presented below:

Field of Management (cont’d)
• Some of the issues to consider under the four
identifiable areas are:
• In farm management much emphasis is placed

conventionally on production and little on
personnel management.
• The general tendency today is to lay less stress on

production methods and more on other areas,
particularly aspects of personnel management
such as staff motivation.
Objectives of Farm Management
• The primary objective of management is profit
maximization.
• However, only few businesses and farmers aim

simply at profit maximization.
• This may be due to the several risks and uncertainties,

capital and social constraints.
• In general, people engage in business in order to

maximize their satisfaction, which may come from a
combination of several objectives, one of which is to
make profit on their operations.
Objectives of Farm Management(cont’d)
• Naturally, profit-making provides income to the
owners of the business; it is one of the means of
keeping a business in being by providing
contributions that can be retained in the business to
maintain assets in good condition, and to add to
them for better performance.
• The most important of other objectives are:

adequate cash income in commercial farming and
adequate diet in subsistence farming.
• In commercial farming, the popular business
objectives include:
1. High cash income (although profit is generally

measured in cash it may, be represented by a rise in
the value of assets or a reduction in debt).
2. High return on capital
3. Capital growth i.e. business expansion. It may be

more important to expand the business so that a son
may join it later than aim at maximum profit now.
4. Personal satisfaction (and beliefs); e.g.
- Management may prefer an enterprise with a very
simple and familiar easily controlled system that gives
an agreeable way of life;
- people may desire to own and use machines because a

neighbour has one, or as a display of wealth, regardless
of the returns;
- a breeding herd may be kept for the love of it or as a

prestige. Moslems are unlikely to breed pigs (or
Apostles to grow tobacco) no matter how profitable
they may be.
Objectives of Farm Management (cont’d)
5. Social responsibilities of management:
- Management may find the need to retain long-
serving but old and sick workers on humanitarian
grounds;
- maintain a good public image at the expense of
maximum profit;
- raising soil fertility;
- reducing soil erosion; etc.
6. Security: - Low but stable profits may be more

desirable than maximum but uncertain average
profits.
Management Decision Making
• Decision-making is the activity of selecting from
among possible alternatives, a future course of
action.
• It is concerned with getting the right things done

in order to solve some problem at a given time.
• The process of decision-making can be divided

into the following steps:
Management Decision Making (cont’d)
1. Identify the precise problem through
observation.
This includes both physical examination of
objects like crops and livestock, and mental
observations such as the study of price trends and
market outlets, the examination of experimental
results and the collection of data, e.g. the keeping
of farm records.
One must be sure one is solving the right problem
and as such, the decision maker should formulate
the problem carefully so as to ensure that:
(a) there is in fact a real problem to be solved, and
(b) the problem (if it exists) is not a combination of a

number of unrelated problems all of which require
separate treatment.
2. Develop all possible alternative solutions:
• All possible alternatives for solution should be
considered.
• There are usually several reasonable alternatives,

and an alternative that is not obvious often proves
best.
• Even “no change” is an alternative, which must

not be overlooked.
• Indeed, there are several steps to stagnation, which
must be avoided, namely:
a) We have never done it that way
b) We are not ready for that
c) We are doing alright without it
d) We tried that once
e) It costs too much
f) That is not our responsibility
g) It would not work for us.
3. Analyse observations and test alternative solutions
to determine the most likely solutions.
• The manager should assess the variations in future

costs, product prices and yields, and their effects for
each likely alternative solution using simple
techniques.
• Examples of simple analysis would be :
- calculations from farm records of crops and animals,

yields and their comparison with similar yields on
their farms, which are available in published form;
- the examination of animal births and deaths records so
as to see how well the livestock are performing;
- the calculation of figures for labour units per hectare,

and for output and income per hectare, per labour unit,
per livestock unit, etc.
• There are of course many other techniques of analysis

currently employed by good farm managers.
• Also, the effects which are hard or impossible to

quantify, e.g. staff morale should be assessed.
4. Select the best course of action: In choosing the
best alternative solution, the decision maker should:
a. consider the costs and benefits of each alternative
b. determine which will give the best results for the least
effort
c. find out whether the solution requires a long and
consistent effort or an urgent action
d. ascertain who will carry out the course of action and
whether it will suit them.
5. Take Action:
• In many situations, the decision making manager
is not the one who will carry out the effective
action demanded.
• He can, however communicate to others what

they ought to be doing and, by regular review and
reporting back sessions, encourage and motivate
them.
Farm Planning
• Farm planning is the process of designing a
programme of action for a farm to ensure an efficient
use of available resources.
• The steps or procedures involved in planning include

the following:
1. Decide on objective – profit maximization or food
satisfaction
2. List the available resources and estimate the resource

requirements for the farm. E.g labour, seed and
fertilizer.
Farm Planning (cont’d)
3. List alternative enterprises such as types of crops to
be grown and/or livestock to be raised.
4. Estimate the costs and returns for possible

alternative combinations of enterprises.
5. Choose combination that gives the maximum

profit/satisfaction.
6. Prepare a long-term plan for land-use. E.g. farming

system, soil and water conservation measures, etc.
7. Prepare a plan for financing the project
8. Prepare a plan for the marketing of produce (or

marketable surplus in case of semi-subsistence
farmers).
(nb. marketable surplus is the surplus of food

produced by the farmer over the consumption
requirements, of his/her family).
• A good plan is that which shows that the steps listed
above are realistically prepared i.e.
1. Resources are realistically appraised
2. Land use is well planned for production, fertility

maintenance and erosion control
3. Inputs are well estimated over the season or several

seasons
4. Financial changes are well anticipated, etc.

Farm Control
• It is the management function that provides a feedback
of information as the plan is executed.
• This is the function by which performance is closely

monitored to achieve business objectives.
• In the control process, actual results are regularly

compared with the plan or budget; variations are
identified and explained quickly; and remedial actions
are taken whenever variations are serious.
Farm Control (cont’d)
• A control system ensures that its finances are on
course i.e. assets are properly protected and fully
used, transactions are correctly recorded and its
financial position is correctly presented at suitable
intervals (financial control).
• It also ensures that actual work done closely

follows the overall plan (and orders given) for a
smooth and successful operation through a
monitoring mechanism (operational control).
Areas to be managed
• The four main inter-related but separate business areas
to be planned and controlled are: production, finance,
personnel and marketing.
1. Production: - Production management is especially

concerned with having the right materials, machinery,
labour and supervision available in the right amounts,
at the right place and at the best time.
• Owing to seasonality of production, timing of jobs,

such as planting and harvesting is particularly critical.
Areas to be managed (cont’d)
2. Finance:- Financial management includes
obtaining sufficient funds and ensuring adequate
cash flows for current activities and, in the longer
term, obtaining capital growth.
• It is also concerned with ordering inputs to best

advantage, keeping stocks at economic levels,
keeping assets in good working order, and
honouring financial obligations at the right time.
3. Personnel:- Important aspects of personnel management
include:
- staff selection (getting the right person into the right job),
- reward structures, and
- organization or fixing the responsibilities by which activities
are delegated to staff and the formal relationship set up
between staff.
• Good staff control will keep an adequate, but not excessive,

work force and raise its efficiency. Control of junior staff is a
continuous, complex job and the methods used vary widely.
• However, the aim is to communicate with, train and motivate

staff so that they work efficiently towards the firm’s
objectives.
4. Marketing:- The marketing task is basically to match
production with market needs.
• This requires decisions on:

- selecting marketing outlets (whether to sell eggs in a
main centre or to a local hotel),
- advertising, and
- presentation (whether to sell potatoes in bulk, bags or
small plastic containers).
• Knowledge of the market situation and trends, such as the

relative profitability of alternative outlets, the exact wants
of buyers and possible new market opportunities, is
necessary.
The Need for Business Management in
Farming
• Modern farming is a business and often involves heavy
capital investment and making (of) decisions that will
affect profit far into the future.
• Producers have an objective (or objectives), which they

want to achieve by allocating scarce resources – land,
capital and labour, hence they need to draw up plans
and procedures ahead of anticipated possibilities for
management decision-making.
• Many small farmers in the tropics lack managerial

skills when they advance from traditional, subsistence
farming to the less-known commercial field.
The Need for Business Management in
farming (cont’d)
• They often fail to distinguish between income and
profit and have an excessive fear of debt.
• An able manager must be competent in both the

technical activities of production and business
activities such as financial planning, personnel
control and marketing.
• Good management will always obtain a better

return than poor management, using the same
quantities of land, capital and labour.
Factors Affecting Managerial
Effectiveness
• Managerial effectiveness refers to the level of
achievement of business objectives.
• Differences in output and profits within a single

farming system or village, or between averages of
groups of farmers following different farming
systems are only partly explained by differences in
the amount and quality of resources used, or by
things like pests or sickness.
Factors Affecting Managerial Effectiveness (cont’d)
• They are mainly due to differences in managerial

skills and therefore in the effectiveness of
management.
• The results of the most successful farmers are

achieved through good management.
• The main qualities related to job effectiveness are:
1. Experience
2. Education and training
3. Personal characteristics
4. Development of managerial skills
5. Age
1. Experience: Experience in the type of farming in

which a farmer (or farm manager) is engaged
raises his managerial effectiveness.
The more experienced a farmer is, the more
effective he becomes.
2. Education and Training: Education and training

provide, at first hand, theoretical and practical
knowledge required in the business, and qualifies
a manager to carry out his duties.
• The higher the theoretical and practical

background of a manager, the better equipped he is
and the better the effectiveness.
• Several studies indicate that the ideally qualified

manager combines adequate education with both
technical training and experience.
3. Personal Characteristics: Most successful managers
have the following qualities:
a) Willingness to work hard – very hard when necessary.
b) Courage – to innovate, invest and expand
c) Toughness – equivalent almost to ruthlessness at
times/pitiless and relentlessness)
d) Self-Confidence and will power amounting at times
to excessive enthusiasm
e) Honesty
f) Ability to inspire to get on with and control people.
g) Resilience to try again when knocked down
h) Good health
4. Development of Managerial Skills: Certain
important managerial skills can be developed
through experience or training.
• The most important of these are probably observation,

analytical ability, decision-making and implementing,
numeracy and communication skills.
5. Age: Young men, especially those with the greatest

desire to maximize their incomes, tend to be
progressive and innovative and, therefore, more
preferable to older men with more experience.
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 which are not the result of human effort; e.g.
land, water, minerals, forests. Land is the original
indestructible properties of the soil.
Types Land, water, minerals, forests, etc.
Land: In terms of ownership: Stool land /Community land/
Govt 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, leasehold, inheritance,
Acquisition/source gift
Units of In acres or hectares. An acre of land is about the size of a

Measurement standard football field, and one hectare is about two and a half
times that size
Reward Rent (for leased land)
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/ nnuboa/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 faster but harvest or weed 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
• One scale of conversion commonly used is based on the assumption

that the work done per hour by women is two-thirds and that by
children under 15 years of age is one-third of that done per hour by
men (adult males)
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 2/3 12
Children 6 4 1/3 8
(under 15yrs)
Total man-days - - - 36
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 (fixed or long term assets)/Consumable (current or

short term assets); e.g. of Fixed Assets: buildings, roads,
machinery & tools, permanent tree crops, e.g. of Current
Assets: fertiliser, pesticides, seeds, cash.
Mode of Borrowed, own savings, outside equity (i.e. contribution from

Acquisition/source part owners), grant/gift
Units of Physical quantities, value terms, cubic capacity, floor space

Measurement
Reward Interest
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

roughly 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 (cont’d)
• 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 only some of them are fixed in relation to
the level of activity.
• 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 decision making, common

costs do not.
• Examples of common costs:
- machinery and building costs,

- overheads such as salaries and wages, administrative expenses,
bank charges, rent and rates, general insurance, cost of owning
fixed assets e.g. depreciation, licenses and insurance.
• Some costs contain both variable and constant elements e.g.

depreciation, 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, or 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 ¢
Sale of maize: 8 bags @ ¢50.00 each 400
Home consumption: 2 bags @ ¢50.00 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 @ ¢3.00 per man-day 120
Seed: 20 kg @ ¢4.00 per kg 80
Fertilizer: 2 bags @ ¢75.00 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 ¢ variable cost 0.38
• Gross margin may be defined for each enterprise and for the
whole farm.
• When the gross margin is defined for each enterprise, e.g.
maize, it is referred to as Enterprise Gross Margin (EGM),
and
• when defined for the whole farm, e.g. 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.

Maize (¢) Groundnut (¢)
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 ¢ variable cost 0.38 0.89
• Enterprise Gross Margin per Ha of maize is ¢150

• Enterprise Gross Margin per Ha of groundnut is ¢340
• Whole Farm Gross Margin (2 Ha) is (¢150 + ¢340) = ¢490
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.
• It represents the reward to the farmer and his family

for their own physical effort (manual labour),
managerial effort and interest on their own capital
invested in the farm business.
• It includes the value of farm products consumed by

the farmer and his family, and therefore, not
necessarily cash income. i.e.
• 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.
• 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 value product (MVP) is the addition to total
revenue (or value of production) due to one unit
addition of an input.
• 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 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

• Computation of MPP, MVP and MFC
Input (X) in Output (Q) in ∆Q ∆X MPP MVP MFC
bags mini bags Pq = ¢10 per mini bag Px
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
• In the above example MVP = MFC at the point where
4 bags of input yields an output of 34 minibags.
• Thus the economic principle of marginal analysis

states that it is profitable to continue to supply inputs
(e.g. fertilizer) to an enterprise so long as the increase
in revenue due to the addition of each unit of input
exceeds the cost of that unit of input added.
• Alternatively, the optimum level of production occurs

at the point where marginal revenue (MR) equals
marginal cost (MC)
• i.e. MR = MC
• Computation of MR and MC
Input (X) Output (Q) in TC TR ∆Q ∆TR ∆TC MR MC Profit
in bags 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

MARGINAL COSTING
• Profitability of an enterprise may be estimated using two
approaches:
• 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 and

ignores common costs (i.e. costs which would change with a
change in the level of output or activity.
E.g. the area cropped or number of livestock kept.
Marginal Costing (Cont’d)
• It is referred to as the marginal costing approach.
• In this 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.
The second approach uses both variable and common costs
for the estimation of enterprise profit.
This approach is called full cost accounting or absorption

costing. It may also be referred to as cost accounting.
In the 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.
• Example of Marginal Costing
Milk Maize Cotton Total
¢ ¢ ¢ ¢
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.
• Maize has the same gross income as milk but
provides almost twice the contribution.
• Cotton has less output 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.
• Assume the common cost of ¢180 have been

allocated to enterprises in proportion to their gross
outputs.
• The share of the common cost is ¢70, ¢70 and ¢40,

respectively for milk, maize and cotton; and
enterprise profit estimated as follows:
• Example of Absorption Costing
¢ ¢ ¢ ¢
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 ¢20 and

suggests that whole farm profit could be raised
merely by dropping milk production.
• However, dropping milk production would reduce total
profit because the common costs allocated to milk would
remain.
• Effect of Discontinuing Milk Production

¢ ¢ ¢ ¢
Gross Income - 300 170 470
Material costs - 130 70 200
Labour costs - 80 10 90
Total variable costs - 210 80 290
Common costs - 110 70 180
Total costs - 320 150 470
Profit (Loss) (20) 20 0
• As shown in the table, total profit could fall from ¢50 to zero;
and the implication now is that maize production should also
be dropped.
• Absorption costing (or cost accounting) is misleading
sometimes because the enterprise profits so obtained depend
on an arbitrary allocation of common costs.
• Enterprises may seem to be unprofitable when in fact they

are contributing to 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.
Valuation
• Valuation is an assessment of the worth of an asset in
monetary terms (or attaching prices to the assets).
• Valuations are required in farm business for two main

reasons:
1. to find the value of assets for entry in the books of

accounts – the balance sheet as at the date to which
the accounts are drawn, and
2. to find the cost of stock used during the period

concerned
Types of Valuation
• The different types of valuing farm assets are:
1. Valuation at cost,
2. valuation at market prices,
3. valuation at net selling price,
4. valuation at cost less depreciation,
5. valuation by reproductive value or replacement
cost,
6. valuation by income capitalization.
Valuation (cont’d)
1) Valuation at cost is the use of actual cost of purchasing
or acquiring the asset for valuation.
2) Valuation at market prices is the use of the prevailing

market prices that could be obtained if the asset were
offered for sale at the present time for valuation.
3) Valuation at net selling price refers to the use of

prevailing market price less marketing cost for valuation.
4) Valuation at Cost less depreciation is the value of an

asset when the cost of use of the item (depreciation) is
deducted from the cost of acquiring it.
5) Valuation by reproductive value or replacement
cost is how much it would cost to reproduce or replace
the asset at present methods of production.
6) Valuation by Income capitalization is computed as:
V = Y/r
Where V = present value

Y = future annual net income
r = market interest rate or capitalization rate.
• E.g. A one-hectare farm yields an estimated return of
¢2,000 indefinitely into the future. What would be
the value of the farm at an interest rate of 10%?
Y = ¢2,000
r = 10% = 0.1
V = 2,000 / 0.1 = ¢20,000
• Hence, the farm is worth ¢20,000.
• Valuation may take any of these forms depending on

the type of asset (or items owned).
Limitations
Valuation at Cost
• Information on original investment cost ceases to
be useful or significant after the business has been
in operation for some time, and no longer reflects
the present networth.
Valuation at Market Price

• Values can either be understated or overstated
Valuation at Net Selling Price
• While it can be applied to crops or livestock produced
for market, it has little meaning when applied to such
things as buildings or machines, which are to be worn
out.
Valuation by Reproductive Value or Replacement Cost

• Method is obviously adapted to long lived or fixed
assets; it has little application to short lived materials.
• But it might not be desired to reproduce the old
building in the same form or with the same design.
• Valuing different types of assets:
1. for purchased farm inputs (or supplies) such as
fertilizers and chemicals, either valuation at cost
or valuation at market prices may be used.
2. for items ready for market (e.g. stored produce)

valuation at net selling price may be used.
3. items which have a useful life of over several

seasons such as equipment and buildings will be
valued at cost less depreciation.
4. to estimate the value of fixed assets in times and
areas of exceedingly high inflation valuation by
reproductive value or replacement cost is used.
• When fixed assets have been acquired a long time

ago, they may be valued at replacement cost less
depreciation.
5. for an asset with a constant annual income (or

rent) stream in perpetuity, such as farmland,
valuation by income capitalization is used.
Depreciation
• Depreciation is the gradual reduction in the value of an asset
over a period of time, usually a year, due to age and use.
• The main causes of depreciation are:

1. Wear and tear (with use) caused by the wearing out of an
item through use. Hence Use depreciation;
2. Obsolescence – caused by technological improvements

which render the old machines less useful or desirable as
compared to newer ones(i.e. it is the loss in value as a
result of technological improvement resulting in
production of better machines); hence Time depreciation.
Depreciation (cont’d)
3. Deterioration (with age): This is a loss in value
caused by elements of nature as the asset gets older
and older.
• For machinery, this might be rust; for buildings,

decadence; for livestock, ageing.
Purpose of depreciating an asset

• The major purposes for depreciating an asset are:
i. to estimate current value;
ii. to calculate expense/cost; and
iii. to adjust taxable income
Methods of Depreciation
• Three commonly used methods of depreciation,
namely
1. Straight line method
2. Declining balance method
3. Sum-of-the-years digits method.
1. Straight line method:

Annual Depreciation = Original cost – Salvage value
Expected useful life
• The salvage value is the remaining (or residual)
value of the asset after its expected useful life in
the business has been covered.
• The useful life of an asset is the period of time

after which it is no longer economical to maintain.
• E.g. Suppose a vehicle has a useful life of 5 years

and costs ¢10,000.
• If the salvage value is estimated as ¢1,000 then
Annual Depreciation = ¢10,000 – 1,000
5
= ¢1,800 per year
• The method assumes that the loss in value of an

asset at the end of each year is the same throughout
the useful life of the asset.
• It is simple, easy to work out and favoured by most

accountants.
• The straight-line assumption is convenient but not
always correct since assets may not necessarily
depreciate evenly throughout their life space,
especially machines in which repairs and
maintenance costs increase, as they get older.
• It is really suitable only for very durable assets

like fences and buildings that need the same
maintenance throughout their lives and are not
liable to large changes or improvements in design.
2. Declining balance method
• This is also known as Diminishing or Reducing
Balance Method. Calculated as:
Remaining book
Fixed
Annual Depreciation = percent x value at beginning
of year
Or (2 / n) X R
• Where n = useful life (in years)

R = Remaining book value at beginning of year.
• Annual Depreciation by the Declining Balance
Method
Book value at start of Depreciation Book value at end
Year year (¢) (2/n x R) of year (¢)
(¢)
1 10,000 4,000 6,000
2 6,000 2,400 3,600
3 3,600 1,440 2,160
4 2,160 864 1,296
5 1,296 518.40 777.60
• Under the method, no salvage value is deducted from

the original cost.
• About twice the rate under the straight line method can
be applied.
• The value at the end of the 5th year is the salvage value
of the asset with this method.
• By this method a fixed percentage of the remaining

book value is written off each year.
• The method assumes that annual depreciation falls by a

fixed percentage of its value at the beginning of each
year as the asset ages and, therefore, allows larger
values to be written off in the early years and smaller
values in later years.
3. Sum-of-the-years digits method
Remaining number of
useful years at start of year Total
Annual
Depreciation
= x Depreciation
Sum of digits of useful life
• The denominator is the sum of digits representing

the individual years from first to the last year of
expected useful life while the numerator is the
remaining number of useful years at the start of the
year.
• Thus given the useful life of 5 years, the estimated
denominator is 1+ 2+ 3+ 4+ 5 = 15, and the fractions
are:
5/15 for year 1,
4/15 for year 2,
3/15 for year 3,
2/15 for year 4, and
1/15 for year 5.
• Depreciation for year 1 = 5/15 of total depreciation (i.

e. original cost – salvage value), etc.
• Annual Depreciation Using Sum-of-the-years Digits Method
Year Fraction Annual Depreciation (¢)

1 5/15 3,000
2 4/15 2,400
3 3/15 1,800
4 2/15 1,200
5 1/15 600
Total = 15 9,000
• This method is a compromise between the straight

line and the rapidly diminishing curve of the
diminishing balance method.
FARM MANAGEMENT
INFORMATION
FARM MANAGEMENT
INFORMATION
• The term ‘management information’ may be
interpreted widely to include financial accounts,
statistical data, budgets, progress reports, graphs or
charts, technologies and procedures, etc., required for
decision making.
• It may be divided into four main groups relating to:

1. future probabilities and expectations;
2. present results and performances;
3. past results, performance reports and general
background data; and
4. past, present and future combined in the form of
trend reports, graphs or charts.
The Need for Management Information
• Why needed: To run a business effectively a manager

must make decisions.
• Wherever possible decisions should be based on facts,

though opinions may also be relevant. However,
information is seldom complete so decisions are
mostly made on imperfect knowledge.
• The more managers’ decisions are based on reliable

information rather than inspired guesses, the greater
the chance of better decisions being made.
Need for Management Information (cont’d)
• What for: Management information, for tropical

smallholder farming is needed to:
1. describe present farming systems

2. estimate inputs and outputs
3. estimate costs and returns
4. plan changes to present systems, and
5. measure the effects of changes after they have
been made.
Sources of Information
• The sources of data, which any farm management
advisor should draw upon, are those of:
i. Local experience (of agricultural extension
officers and individuals in the area)
ii. Research reports (both published and
unpublished)
iii. Field investigations (Case studies, farm surveys,
cost-route method)
iv. Census data
v. Technical experiments (on research stations and
on-farm trials, etc.).
Sources of Information (cont’d)
i. Local experience: Agricultural extension officers
and individuals in the area can provide information
on local farming systems and local estimates of
inputs and outputs.
• The reliability of such estimates depends on the

original source. If they are based on current surveys
and experiments under similar conditions they may
be accurate.
• If, however, they are merely impressions gained from

working in the area, the errors could be large.
ii. Research Reports: Research reports may provide
information on agricultural inputs and outputs.
• The data may not be directly applicable to the farms
currently under investigation.
• However, the difference between regions and

between time periods may not be significant when
compared with variations between farms within one
area.
• In particular, the average annual labour inputs per

acre of a given crop may not vary significantly from
one country to another or from one time period to
another.
iii. Field investigations: There are 3 main types of field
investigations:
1. case studies,
2. farm surveys, and
3. the cost–route method.
• Case studies involve few visits to a single representative

farm.
• Farm surveys involve possibly one visit to a large number

of representative farms known as sample of farms.
• The cost-route method refers to repeated visits to the same

sample of farms over an extended period, involving direct
observation.
• It is generally claimed that case studies method
provides the most accurate and reliable data,
particularly for items such as labour use and crop
yields.
• iv. Census data: Censuses are carried out mainly by

government statistics departments e.g. the Ghana
Statistical Services, Statistics and Research
Directorate (SRD) of PPMED.
• These studies do not give input-output relationships or
price data.
• The main types of information gathered for farm
management concern crop areas, size of farm holdings,
crop yields and livestock counts.
v. Technical experiments: Technical experiments carried
out on research stations or even on-farm trials, give
precise and accurate data on the effects of varying certain
inputs on the output of a particular crop or animal under
certain specific conditions.
• Farm trials are usually necessary because both labour

inputs and product outputs are generally much higher
under experimental conditions than they are on farms.
• Technical experiments are likely to give a biased picture

of the inputs and outputs likely to be found in practice.
• A further difficulty here is that most research work

concerns pure crop stands, while farmers almost
invariably practice mixed cropping
Farm Records
• Farm records are statements or documents on activities
carried out on the farm.
Reasons for keeping farm records:

Essentially records are kept to:
1. check and control current physical performance. This
is done by comparing yields and inputs between
seasons, land (fields), and livestock, or with published
“standards” of similar enterprises.
2. provide basic data for assessing the profitability and

capital position of a farm or farm enterprise within a
given period of time.
Farm Records- reasons (cont’d)
3. provide basic data needed for planning (and
budgeting).
4. provide information to guide future management

decision making.
Types of Farm Records
• Farm records may be classified into two categories:
I. Physical records, and
II. Financial records.
• Physical records show units of output and inputs, and

financial records relate these to income and expenditure
• Physical and financial records complement each other.
• Physical records provide some of the necessary information

from which detailed financial information can be produced
regularly.
I. Physical Records
• These include:
1. Machinery and Equipment use records
2. Stock control record
3. Production records
4. Labour records
5. Supplementary records, e.g. legal documents on
land, farm map, tape recorded and written history
on land acquisition, etc.
Physical Records (cont’d)
1. Machinery and Equipment Use:
• Three main units recorded are: area covered, hours used
on the job and litres of fuel used
Machinery and Equipment Use Record

Enterprise……………………….
Date Type of Machinery or To t a l A r e a Hours Used Litres of
Operation Equipment used Covered Fuel Used
2. Stock Control Record
• It records the flow of stock into and out of the business. It
provides the full details of individual receipts, issues, and
balances of stock in hand each day.
• It ensures that too much stock is not kept or just sufficient

stock is kept to prevent production from stopping if suppliers
do not deliver on time.
• It also ensures timely detection of losses.
Stock Control Record Stock: Fertilizer
Date Purpose/Remark In Out Balance
1/10 Received 64 bags at ¢ .. each - 64 bags
20/10 Maize - 37 27
10/11 Pastures - 11 16
15/11 Cowpeas - 7 9
3. Production Records
• They are records of quantities of inputs used in the farm
and outputs obtained in crop and livestock production.
• Crop records include hectares under cultivation, amount

of seed and other inputs used in various crops, planting
and harvesting dates, and crop yields.
Crop Production Record

Date Activity Quantity of Inputs Used Quantity Harvested
1/10 Land preparation 5 hectares
20/10 Planting 100 kg (seed)
10/11 Spraying 10 litres (spray chem.)
Production Records (cont’d)
• Livestock production records include type of livestock,
number and weight, quantities of feed intake, production rate
(e.g. number of eggs per day or week, amount of milk
produced per animal, births per animal (i.e. breeding record),
mortality rate e.g. number of deaths per month, number
missing, sales, farm slaughtering and purchases per month.
• Records of diseases may also be kept.

Livestock Production Record
Date Activity Quantity of Input used Stock Number/Remarks

Production Records (cont’d)
Livestock Breeding Record
Name/ID No. of Date served Date of Parturition Number born Notes
Animal
Egg Production Record

House/Pen Number:……………………….
Date Number of Eggs Number of Cracked Total Number of Present Number
Collected Eggs Good Eggs of Birds
4. Labour Records
• Includes type of labour, hours or days worked,
kind of work done or task
Labour Record Farm Size: 1

Date Job No. & Category of Hours Payment Payment Total
Ha Specification Workers Worked in Cash in Kind Payment
1/10 Land preparation 6 (hired)
9/10 Weeding 4 (family men)
2 (family women)
II. Financial Records
• These records provide the basic information for assessing the
profitability and capital position of the whole farm business.
• The basic financial records to be kept will include:

1. Sales and Purchases Record
2. Record of Debtors and Creditors
3. Valuations Record
• Sales and Purchases Records: record daily sales and

purchases and may include quantities sold or purchased of an
item, unit price, and total sales and purchases.
• It may be presented as a single table or as separate tables for

sales and for purchases.
Financial Records: Sales & Purchases Records
(cont’d)
Sales record
Date Item Quantity Sold Price per unit Total Sales
Purchases Record
Date Item Quantity Bought Price per Unit Total Purchases
Financial Records (cont’d)
2. Record of Debtors and Creditors
• This is a list of those who owe money (debtors)
and those to whom money is owed (creditors)
together with the amount and the items for which
the money is owed or owing.
• It provides a list of debtors and creditors at the

beginning and end of the accounting year for
preparing income statement
Financial Records (cont’d)
• Record of Debtors and Creditors
Debtors Creditors
Date Amount Amount Signature
Details Receivable Details Payable
3. Valuations Record
• Assets are valued at the end of each year and recorded in the
valuations book.
• It includes a detailed list of all assets, quantities, unit costs,

date purchased or acquired and present value.
Financial Records: Valuations Record (cont’d)
• The following groups of items need listing:
- Fixed and part-fixed capital assets, for example:

land and house,
buildings,
improvements,
plant and machinery.
- Purchased stocks, for example:

fertilizers,
seeds, and
chemicals,
Valuations Record (cont’d)
- Harvested produce on hand, for example:
maize and cowpeas – whether for sale or feeding
fodder
growing crops
livestock
• The record, therefore, contains in addition to the list,

quantities and book values of the items in monetary terms.
• Inventory or stocktaking may be done once every year or

once every cropping season and consists of two steps:
physical counting of the stock and valuation
• Stock Valuations Record

Date Asset Quantity Unit Price Date Purchased/Acquired Present Value
• The basic books and equipment for recording include:
cash analysis book,
valuations book,
wages book,
petty cash book,
petty cash box or safe,
duplicate order book,
cheque book,
counterfoils,
bank paying-in-slip and files.
• The cash analysis book is the master record of all

business transactions made during the year.
• The petty cash book is merely a small pocket
notebook in which small amounts of frequent cash
payments and receipts are recorded separately.
• Items are classified and posted as monthly totals to

the relevant columns in the main cash analysis
book
PREPARATION OF
FINANCIAL ACCOUNTS
Profit and Loss Statement
• Profit & Loss Statement is a financial statement
showing the profitability of the business over a
fixed time period – normally one year.
• It is referred to differently as income and

expenditure statement, income statement, profit
statement, operating statement, etc.
• The profit equation is given as:
• Profit = Gross income – Total Expenditure

Profit & Loss Statement (cont’d)
The Gross income is the sum of value of sales from crops and
livestock, farm produce used at home and product produced
during the year but not sold or used during the accounting
period.
• The expenditure includes:
- direct costs such as raw materials and direct labour;
- direct expenses such as: hiring charges;
- production overheads such as: management staff, utilities,
repairs and maintenance, travel and transport, fuel and
lubricants, and fixed expenses such as: depreciation, rents
and rates, insurance, and interest on loans, etc; and
- administrative and marketing overheads.
• The Profit & Loss statement is normally but not
necessarily laid out with expenditure on the left-
hand side and income on the right hand side.
• Alternatively, it may be laid out in a vertical
format presented below:
Profit & Loss Statement of ABC Farms for the year Ended 31st Dec. 20xx
¢
Gross Income:
Sales 1,200
Produce consumed by household 100
Increase in value of Stock 200
1,500
Expenditure:
Raw materials 500
Direct labour 200
Repairs and maintenance 40
Travel and transport 10
Fuel and lubricants 100
Utilities 25
Rent on land 10
Insurance 30
Depreciation 15
Administrative & marketing expenses 50
980
Profit before Interest and Tax (Operating Profit) 520
Less: Interest on loans 20
Profit before Tax 500
Less: Tax (40%) 200
Profit after Interest and Tax (Net Income) 300
• Uses of Profit and Loss Statement

1. It serves as a basis for the assessment of tax
payable by the business
2. It illustrates the performance of the business upon

which sound judgements can be based to help
future improvements (planning)
Balance Sheet
• The balance sheet is the summary of all assets and
liabilities of the business at a given point in time –
normally at the end of the financial year to show
the capital position of the business.
• It is otherwise referred to as the Networth

Statement
• The balance sheet equation is given as:
Total Assets = Total Liabilities + Net Capital

Balance Sheet (cont’d)
• Assets are the capital resources owned or used by the

business.
• Liabilities are the funds owed by the business and

represent the claims of various suppliers of funds
against the business.
• The excess of assets over liabilities is called the net

capital, or networth and represents the claims of
owners of the business, hence referred to as the equity
capital.
• The net capital figure indicates the ultimate

solvency of the business.
• When total resources (assets) are equal to or

greater than total liabilities the business is solvent.
• When total liabilities are not covered by total

resources, the business is said to be insolvent or
bankrupt.
• The assets are usually listed according to liquidity (or
the ease with which they may be converted into cash)
beginning with land and buildings, which are difficult
to sell at short notice and ending with cash on hand,
or vice versa
• It is desirable to classify assets according to the time

period involved into:
- fixed assets
- medium (or intermediate)
- current assets.
• Fixed assets are long-term assets which are
practically difficult to convert into cash at short
notice to meet current obligations,
e.g. land and buildings, and other permanent

improvements on land such as fences, drains and
tiling.
• Medium term (or intermediate) assets are more

liquid than long-term assets and include plant,
machinery and equipment, vehicles, breeding (or
producing) livestock, etc.
• The medium term assets are often classified under
fixed assets.
• Current assets are those assets likely to be

liquidated within the financial year (or production
period if this is longer).
• They include growing crops, crops in store, trading

livestock, inputs in store, debtors (or accounts
receivable), cash at bank and cash on hand.
• Liabilities are also classified according to the time
period involved into:
- fixed (or deferred) liabilities,
- intermediate and
- current (or short-term) liabilities.
• Fixed liabilities are long-term loans for real estate

development and do not have to be repaid in the
next 5 years but are likely to remain for a longer
time.
• Medium term (or intermediate) liabilities require settlement
in more than one financial year but less than about 5 years,
e.g. loans for purchasing machinery and equipment.
• Like medium term assets, medium term liabilities are also

often considered under fixed liabilities.
• Current (or short-term) liabilities are debts that have to be

paid in the short-term, usually within one financial year.
• They include: short-term loans, bank overdrafts, and trade

creditors, tax payable within the coming year, interest
payable on loan capital, dividends payable, etc.
• The traditional layout of a balance sheet (i.e.

horizontal format)presents the assets on the
right–hand side and the liabilities on the left-
hand side.
• The net capital, which represents the balancing

item, is recorded on the same side as the
liabilities.
Balance Sheet of ABC Farms as at 31st December
20XX
Liabilities ¢ Assets ¢
Fixed 0 Fixed 1,000
Long-term loan Land
Buildings
Fences
Drains
Other improvements on land
Intermediate 500 Intermediate 800

Medium term loan Machinery & equipment
Vehicles
Breeding stock
Current 1,700 Current 950

Short-term loan Growing crops
Overdraft Crops in store
Trade creditors (A/C payable) Trading livestock
Inputs in store
Trade debtors (a/c receivable)
Cash at bank
Cash on hand
Net Capital (or Networth) 550
2,750 2,750
Sources and Uses of Funds Statement
(or Cash Flow Statement)
• It gives a summary of how funds were generated and
how these funds were used during the year.
• Both sources and uses of funds may be classified into

three categories – trading, capital and private.
• Trading accounts need adjustment for non-cash

charges.
• The relevant details can be set out in a statement
showing cash inflows (or sources) and cash outflows
(or disposal of funds)
Sources and Uses of Funds Statement (cont’d)
• e.g.
Sources Disposal of Funds
Trading A/c
Trading profit Trading loss
Decrease in stock Increase in stock
Decrease in trade debtors Increase in trade debtors
Increase in trade creditors Decrease in trade creditors
Depreciation Dividends payable
Tax payable
Capital A/c
Fixed assets sold Fixed assets purchased
(Capital receipt) (Capital payments)
New borrowings/loans Loan repayment (Debt services)
Private A/c:
New equity (i.e. capital introduced Private drawings (for family living
by proprietors) or other investment)
Cash deficit Cash surplus

• The cash outflow (uses/disposal) and the cash inflow
(sources) are summed up separately.
• If the total cash outflow is greater than the total cash

inflow, it means the business has a cash deficit, so the
deficit is added to cash inflow.
• But, if there is a surplus, then the cash surplus is

added to the cash outflow.
• Decrease in stock, decrease in trade debtors, increase

in trade creditors and depreciation of assets are
adjustments for non-cash charges in trading sources
shown in the Profit and Loss Account.
• Depreciation represents an accounting cost which has
not been used and can be made available for financing
operations.
• Decrease in stock represents a release of cash through

sale of stock.
• Decrease in trade debtors implies payment of cash by

debtors, making cash available to the business for use.
• Increase in trade creditors represents further access to

cash by postponing immediate payment for purchases.
• Increase in stock represents a draw on the accounts of
the business to finance the production of the
additional stock.
• Increase in trade debtors constitutes a draw on the

accounts to honour the requests of more debtors, thus
reducing cash available to the business.
• Decrease in trade creditors represents the settlement

of debts, which constitutes a draw on the income of
the business.
Sources and Uses of Funds Statement
(cont’d)
• The sources and uses of funds statement usefully

links the profit and loss statement and the balance
sheet, and aids understanding of the often
confusing position when an accountant’s
assessment of a good profit goes together with
greater bank borrowing.
ANALYSIS OF FINANCIAL
ACCOUNTS
Analysing the Profit and Loss Account
Comparative Whole Farm Analysis (or Comparative
Method of Farm Business Analysis)
• Analysis of Profit & Loss Account involves the

examination of costs in relation to outputs or other
factors of a farm as a whole (not the individual
enterprises which constitute the farm unit).
• Costs are grouped into well defined categories like

labour, machinery, fertilizers, feed, etc; and then
expressed as ratios of output or hectarage, e.g. output per
unit cost of labour
Comparative Whole Farm Analysis (cont’d)
• These ratios are called efficiency factors or indices

and are often used to assess the performance of a
whole farm by comparing with standard ratios (or
average figure) obtained from similar farms in the
area
• This analysis is referred to as comparative whole

farm analysis and the main source of material for
this analysis is the Profit & Loss Account.
Comparative Whole Farm Analysis (Cont’d)
• The starting point of the analysis is to get a
measure of the profitability of the farm.
• Two alternative measures of profitability from the

Profit and Loss account are:
1. Net Farm Income (NFI), and

2. Management and Investment Income (MII)
1. Net Farm Income (NFI)
• This represents the reward to the farm family for

their own manual labour, managerial input and
their capital invested in the farm business.
• This implies that the value of manual labour

provided by the farm family and the value of the
farmer’s managerial input will not be considered
in the account.
2. Management and Investment Income (MII)
• This is the reward to the farm family for their
managerial input and their capital investment in the
business.
• Hence
MII = NFI minus Value of family labour
• The MII is possibly better for use in comparing

returns between farms than NFI because farmers
differ in the amount of manual work which they do.
Hence costing of the manual work done by the farm
family eliminates this variation
• The managerial input of the farmer is not costed so
where there is a paid manager the charge for his
management is not included in the costs when
calculating MII, but if he is a working manager, a
charge for his manual work only is included.
Adjustments in Profit and Loss Account
• Farms differ in terms of land ownership, type of
labour used, source of finance and type of
management; and therefore, introduce variations in the
Profit & Loss Account for farms similar in type and
size.
• For the purpose of comparison of similar farms there

is the need to adjust the Profit & Loss Account to put
all farms on a similar basis based on the following
assumptions:
1. all farms are treated as if they were tenanted;
2. all manual labour were paid for;
3. all farms were self-financed (i.e. no borrowed
capital); and
4. all farms were self-managed
• On the basis of these assumptions the following

adjustments are made to owner-occupied farms.
1. Add rent comparable to that paid for similar farms

(quality and size) in the area to farm expenses
2. Exclude landlord’s expenses (mortgage payments

such as expenses on building and other
improvements, etc) from farm expenses.
3. Include a charge for manual labour supplied by the
farm family in farm expenses at the average rates that
would have to be paid to employees
4. Exclude all interest payments on loans (but not bank

handling charges) from farm expenses .
5. Exclude payments for the managerial element of a

manager’s salary from farm expenses (i.e. only
payment that relates to his physical work on the farm
should be maintained).
• These adjustments to the Profit & Loss Account give

rise to the profitability indicator called the MII which is
more desirable for comparing farms.
Sources of Variation in MII
• If MII per hectare is low, either the value of output
is too low, costs are too high, or both.
MII/Ha = Output - Cost
• To trace the sources of variation, output analysis

and cost analysis are conducted
Analysis of Outputs and Costs
Output Analysis
• The output is determined by:
i. Intensity in enterprise mix
ii. Yield
iii. Product price
(i) Intensity in enterprise mix (i. e. proportion of land

under different enterprises on the farm)
• Some crops are valued higher than others.

• An unduly low proportion of land under high valued
crops could result in low output; e.g. pepper is a high
valued crop compared to cassava.
• Suppose a 3-hectare farm has 2 enterprises – 1 ha
of pepper and 2 ha of cassava.
• If 1 ha pepper gives output of ¢1,000 and 1 ha
cassava gives ¢500, the total value is ¢2,000.
• An alternative combination that will increase total

output will be to increase the area under pepper
and reduce that of cassava e.g.
– 2 ha of pepper = ¢2,000, and
– 1 ha of cassava = ¢500;
– Total output = ¢2,500
Measurement of relative intensity
• The relative intensity can be measured using the
System Index (S.I.).
• This is defined as the farm’s standard output

relative to standard output of similar farms,
expressed as a percentage. i.e.
Farm’s standard Output X 100
S.I. = Standard Output of Similar Farms
• If S.I. < 100 low MII is due to intensity

• ExampleStandard Value of Units of Total Value of
Farm
Enterprise Output per Unit Enterprise Potential Production
(¢) (¢)
Maize 500/Ha 10 Ha 5,000
Yam 1,500/Ha 15 Ha 22,500
Dairy 100/Head 5 Heads 500
Poultry 10/Bird 500 Birds 5,000
Beef Cattle 1,000/Head 50 Heads 50,000
83,000
• Assume similar farms have potential value of
output equal to ¢75,000
• Then System Index = 83,000 X 100 = 110.67

75,000
• This implies that the particular farm is more

intensive than the comparative farm or just as well
as the comparative farm, and therefore cannot be
the reason for the low MII.
(ii). Yields
• Relative yields can be measured using the Yield
Index (Y.I.)
• This index is the ratio of the actual or expected yield
of farm to average yield of similar farms expressed as
a percentage.
i.e.
Y.I. = Actual or Expected Yield of Farm X 100
Average Yield of Similar Farms
If Y.I.< 100 Farm is performing poorly because of the

farmer’s technical disability
If Y.I. > 100 Farmer’s technical ability cannot be blamed for
the poor performance
Example
Enterprise Average Yield on Yield on Farm A Area of Crop % X Crop

Yield in Farm A as% of Yield in on Farm A Area
Region (Mt/Ha) Region
(Mt/Ha) (Ha)
(a) (b) (c) (d) (e)
= (b/a x 100) = (c x d)
Rice 2.0 2.5 125.0 10 1,250
Maize 1.8 1.6 88.9 10 889
Sorghum 1.0 0.8 80.0 5 400
Cassava 8.0 10.0 125.0 15 1,875
40 4,414
Yield Index (Y. I.) = 4414/40 = 110.35

This is a weighted average of indices
• Alternatively,
2.5 10 1.6 10 0.8 5 10 15
Y. I. = ---- X ---- + ---- X ---- + ---- X ---- + ---- X ---- X
100
2.0 40 1.8 40 1.0 40 8 40
= 110.35
• This indicates that the farmer’s technical ability cannot be

blamed for the poor performance.
• It is only partially responsible where some yields are up to

standard and others sub-standard.
• Improvements may be effected by eliminating the
low-yielding enterprises from the system and
replacing them with those which the farmer can
manage better.
• Where there are no feasible alternatives due to

capital limitations or other restrictions,
concentration should be on technical advice so as
to improve the technical performance.
Cost Analysis
• The reasons for high cost are two-fold:
1. High input prices
2. Inefficient use of inputs (i. e. using excessive levels
or quantities of inputs)
• In order to examine costs, some efficiency standards

are employed.
• These standards relate cost to level of input used, and

cost to output generated (note that ‘standard’ is a
measure used as a basis for comparison)
• Examples of Efficiency Standards
1. Labour cost per standard man-day
2. Machinery cost per 1,000 tractor units
3. Output per cedi of labour cost
4. Output per cedi of machinery cost
5. Output per cedi of labour & machinery cost
6. MII as percentage of average capital
• The standard man-day requirement equals the estimated amount

of labour (measured in man-days of work) needed to grow 1
hectare of crop.
Similarly, the amount of labour needed to look after 1 head of

livestock for a year is the standard man-day requirement for that
livestock type.
1. Labour cost per standard man-day
= Labour cost
Standard man-days required
• Suppose the labour cost = ¢150.00

• Number of man-days = 200
• Labour cost per std man-day = 150/200
= ¢0.75 per m-d.
• If labour cost per standard man-day for a particular farm is

greater than for similar farms it implies that the farm is
extravagant in its use of labour or that it is paying its
employees more than other farmers.
• 2. Machinery cost per 1,000 tractor units
i.e. machinery cost X 1000
tractor units (T. U.)
• One tractor unit refers to the amount of work done by

a tractor in 1 hour (i.e. 1 tractor-time).
• The ratio measures the efficiency with which

machinery is being used.
• If a business has a higher machinery cost per 1,000

tractor units than similar business, it suggests that the
business is using very old machines
3. Output per cedi of labour cost = Value of output
Labour cost
• It is a measure of output produced for every cedi spent on

labour.
• If the value for a particular farm is less than for similar
farms, it suggests that either low output is realized due to
low output price, or poor yield, or both.
• Alternatively, labour is being used inefficiently, i. e. level of
output may not be sufficient for the labour force.
• The solution lies in either increasing output or in reducing
labour, or a combination of both.
4. Output per Cedi of Machinery Cost
= Value of output
Machinery cost
• Low output per cedi of machinery cost may result

from either low output value (due to low price or
poor yield or both), or inefficient use of machinery
through the use of very old machinery or over
mechanization, etc.
5. Output per Cedi of Labour & Machinery Cost
= Value of output
Labour & Machinery cost
• Low value implies low price, or poor yield, or both; or inefficient use of
machinery and labour.
6. MII as Percentage of Average Capital

= MII x 100
Average Capital
• Where average capital cost is computed as:
• 0.5 (capital at start + capital at end of year)
• The lower the percentage the lower the returns on capital invested.
Analysing the Balance Sheet
• The health of a business is influenced by the financial
proportion of the assets and liabilities used by the
business rather than by the absolute amounts involved.
• Thus assessment of the capital position of a business is

done by determining financial ratios - a process known
as Ratio Analysis.
• Different ratios are computed to assess/measure the

capital position in terms of liquidity, solvency,
flexibility and stability of the business.
1. Liquidity
• This is a measure of the farmer’s ability to convert assets
readily into cash to meet its short–term commitments; it
reflects the proportion of assets which are in the form of
cash or assets that can be readily converted into cash.
• It is measured by Current Ratio:

Current Ratio = Current Assets >1
Current Liabilities
• A favourable value of current ratio should be greater than 1,

preferably 2 : 1.
• A ratio value of 2:1 implies that there are 2 cedis worth of
short term assets which could be converted to cash in order
to pay off each cedi of short-term liability.
2. Solvency
• Solvency of a business refers to its ability to remain
viable over an extended period of time.
• A business is solvent if the assets are greater than the

liabilities.
• If the assets of the business are less than the liabilities

then the business is insolvent.
• Solvency is measured by the leverage ratio, which

describes the relationship between the indebtedness of
an enterprise and its equity (or net capital).
Solvency (cont’d)
i.e. Leverage Ratio
= Total Liability ; Equity > Total Liability
Equity (Net Capital)
• Low leverage ratios are preferable. A ratio value of

1:1 or less is considered safe. The higher the equity
in relation to total liability the lower the leverage
ratio.
• From the lender’s point of view, the leverage ratio

indicates the problems of recovering loans if the
business fails.
Solvency (cont’d)
• In general lenders seem to prefer low leverage
ratios.
• Therefore, trends towards low leverage ratios are

considered to be indicators of financial progress
(or growth).
• This is very important for banks. (The maximum

acceptable leverage ratio is 1 i.e. business owns as
much as it owes).
3. Flexibility
• It refers to the ability of the business to adjust easily to new
or changing circumstances in order to take advantage of
prevailing favourable conditions.
• Flexibility is measured by the Fixed Asset Ratio given as:

Fixed Asset Ratio = Fixed Assets
Total Assets
• A very high ratio implies that most of the assets are locked
up in fixed capital.
• There is no rule of thumb as to what the ratio should be; but

an increase in the ratio through time suggests it is becoming
less flexible.
4. Stability
• This is the ability of the business to withstand adverse
conditions; and reflects the proportion of the
proprietor’s share in the business in relation to other
forms of capital.
• It relates to long-term solvency of the business.

• Stability is measured by Percent Equity.
i.e. Percent Equity = Equity (Net Capital) X

100
Total Assets
• This represents the proportion of total assets owned by

the business.
Stability (cont’d)
• The higher the % equity of business, the better.
• No rule of thumb exists, but trends can be compared over

the years.
• Increasing trend implies that the business is becoming more
stable.
Example:
Liabilities ¢ Assets ¢
Long term 0 Fixed assets 1,000
Intermediate 500 Intermediate 800
Current 1,700 Current 950
Net capital 550
2,750 2,750
Solution to example
1. Liquidity (Immediate solvency)
Current Ratio = C. A. = 950
C. L. 1700
2. Ultimate or Absolute Solvency

Leverage Ratio: = T. L. = 2,200
N. C. 550
Solution
3. Flexibility: -
Fixed Asset Ratio: = F. A. = 1,000 = 0.36
T. A. 2,750
or = 1,800 = 0.65
2,750
4. Stability:
% Equity = N.C. X 100= 550 X 100
T. A. 2,750
= 0.2 = 20%
Limitations of Ratio Analysis
• Ratios are at best indicators of the business’ position
with respect to some goal or standard.
• A change in the ratio might serve as a warning signal

to solve the problem.
• Balance sheets from which ratios are computed reflect

the firm’s past and may not always be a reliable guide
to its future.
• They are usually several months old when prepared.

Nevertheless study of a series of balance sheets of the
same business prepared in the same way, can reveal
much about its overall health and direction.
• MANAGEMENT ACCOUNTS
MANAGEMENT ACCOUNTS
• Management Accounts are records of

transactions used to assess the performance of
individual enterprises and to aid future decision
making and planning.
• It reveals the strengths and weaknesses of the

individual enterprises
Purposes/Requirements
1. Checks performance of individual enterprises.
Checking performance requires regular and timely
information
2. Aids future decision making. This requires knowledge

of strengths and weaknesses of individual enterprises.
3. Aids planning: This also requires detailed input-output

information.
• Note: Management Accounts has more defined variables

but Financial Accounts deals with the Whole Farm as a
unit.
Approaches to Management Accounting
(or Enterprises Accounting)
• Two approaches
1. Full cost accounting
2. Gross margin accounting
• In Full Cost Accounting, all costs of the business (i.e.

both common and variable) are allocated to the
individual enterprises; while in Gross Margin
Accounting only variable costs are allocated to
enterprises.
• The resulting surplus is termed gross margin for the

enterprises.
Approaches to Management Accounting
(cont’d)
• The gross margin shows the contribution of the
enterprises to the recovery of the common (or
fixed) costs.
• The common (or fixed) cost includes regular

labour, machinery cost, rent and general overheads
like electricity and water bills, etc.
Full Cost Accounting
• For two enterprises e.g. poultry and cotton
∏ (poultry) = Q (poultry) – V (poultry) – Share of Fixed Cost (poultry)
∏ (cotton) = Q (cotton ) – V (cotton ) – Share of Fixed Cost (cotton )
• Where,
∏ = profit
V = variable cost
Q = output (in value terms)
Whole Farm Profit (∏w) = ∏(poultry) + ∏(cotton)
Thus the profit for the whole farm is the sum of profit
from the individual enterprises.
Full Cost Accounting (cont’d)
Allocation of Fixed Cost in Full Cost Accounting
1. Full-Time Regular Labour Cost:-
• Calculate the average labour cost per man-hour
and charge according to man-hours spent on each
enterprise
i.e. cost/man-hour or cost/man-day.
• This requires a record of the number of man-hours

devoted to each enterprise, and an estimate of the
total cost of labour.
2. Allocating Machinery Cost:
• Calculate the average cost per machine-hour and charge according to
hours spent on each enterprise i.e. cost/machine-hour.
• When machinery is shared between enterprises, allocation of costs will

require keeping a log book for all major services of machinery.
• The log book records time spent and type of activity.
• This is an additional record keeping to be able to allocate this type of

cost.
• When machinery is of a specialist nature, such as combine harvester or

maize sheller, its cost can be allocated to a particular enterprise.
3. Rent
• Allocate rent cost at a flat rate on per hectare basis.
• However, setting a flat rate may result in

underestimating some lands since high quality land
will cost more than low quality land.
4. Overheads:
• Allocate overheads per enterprise arbitrarily on
proportion basis.
Limitations of allocating Fixed Cost
• Too much time is required for recording and
analyzing information, yet sometimes cost must be
allocated arbitrarily.
• Therefore, cost allocation may be unreliable in the

end.
Advantages of Full Cost Accounting
1. It provides some idea about the cost of production,
which is an important basis for determining selling
prices, either by the farmers themselves, or by the
government for the setting of producer prices.
2. Full costing of enterprises within a business over a

number of years will provide an indication of the
trends in profitability of the individual enterprises of
a business.
3. Full costing can be useful for enterprises which share

few resources, if any, with the rest of the business.
Gross Margin Accounting
• Given that the farm comprises two enterprises:
poultry and cotton,
GM (poultry) = Q (poultry) - V (poultry)

GM(cotton) = Q (cotton) - V (cotton)
Whole Farm Gross Margin (WFGM)

= GM (poultry) - GM (cotton)
Whole Farm Profit (∏w) = WFGM - Total Fixed Cost

Gross Margin Accounting (cont’d)
• Sales information can be derived from the receipt
section of the cash analysis book.
• Where one of the enterprises has more than one type

of output, separate record for each type of output
should be maintained.
• e.g.
– chicken and eggs
– the layer enterprise
– rice milling enterprise (i.e. the milled grain and the chaff)
– groundnut oil processing enterprise (oil and cake/paste)
– palm oil processing (oil and kernel or kernel oil and cake)
Using Gross Margin
• Gross margin account is the basis for comparing the
business performance at the individual enterprise levels.
• It has two principal uses:

1. Analysis for comparing enterprise performance
2. Farm planning
• The analysis for comparing enterprise performance involves

the determination of indicators which can be used to:
a. compare trend (i. e. performance over a period of time)
b. compare performance with a business target or goal
c. compare performance with average of similar farms
Using Gross Margin (cont’d)
• The measures or indicators for analyzing performance
in Gross margin accounting are:
1. Enterprise Gross Margin (EGM) per hectare
2. EGM per head
3. EGM per man day
4. Output or EGM per cedi labour cost
5. Output or EGM per cedi machinery cost
6. Output or EGM per cedi machinery and labour cost

Efficiency Indices
1. Labour Efficiency Index

EI = Standard man-days (SMDs) required X 100
Standard man-days used
• If EI ≥ 100 implies high efficiency

Efficiency Indices (cont’d)
2. Livestock Efficiency Index
• For livestock, assuming feed is the major
component,
EI = Enterprise feed cost

Enterprise output
• If feed cost per unit of output (EI) is increasing, it

implies inefficiency
• The gross margin analysis involves the following steps:
i. determining the level of output produced of enterprise
(i.e. price and yield)
ii. determining the pattern or composition of variable

costs incurred by each enterprise. This is known as
‘doing enterprise checks’ (or relating the output levels
of each enterprise to the variable cost).
i.e. output/variable cost.
e.g. output of poultry per labour cost.
iii. estimating the gross margin contribution of the

individual enterprise on per unit basis (i.e. Enterprise
Gross Margin per hectare or per head)
Advantages of Gross Margin Accounting
• It is simple because it overcomes the problem

of allocating common costs to enterprises
• It aims at maximizing contribution from the
resources available
• It helps in making decisions about enterprise
combination (product mix) such as introduction
of a new enterprise or changing the proportion
of existing ones.
Problem of Gross Margin Accounting
• A particular cost item may contain both

common and variable elements
(e.g. depreciation, irrigation water, electricity

and telephone)
FARM BUDGETS
Farm Budgeting
• A budget is a detailed statement of a farm plan or a
change in farm plan, and the forecast of its financial
results.
• It has both physical and financial elements.
• The physical element involves:

- What to produce
- What resources are required, and
- How much of product is expected.
• The financial element, on the other hand, involves:

- expected cost
- expected returns, and
- expected profit
Purpose of Budgets
• Budgets are used for assessing different plans
before choosing a plan to follow
• They are used for setting out consequences of

adopting a change in plan
• Budgets form the basis for budgetary or

operational control by providing a standard for
comparing with the results achieved (i. e. expected
vrs. actual results).
Types of Budgets
1. Complete budget 4. Break even budget
2. Partial budget 5. Capital budgets
3. Cash flow budget
1. Complete Budget (or whole farm) :

• It is a plan for the whole farm or for all decisions of
one enterprise, and includes all expenses and receipts
likely to be incurred or realized.
• It is used either for starting a new business or for a

major change such that many of the cost and revenue
factors are affected.
Types of Budgets (cont’d)
2. Partial Budget:
• It is an estimate of the outcome of a small change in
farm plan.
• It is used to forecast the effect of a change in an

existing plan only, and does not consider absolute
values.
3. Cash Flow Budget:

• This is a monthly or quarterly projection of future
cash inflows (cash receipts) and cash outflows
(disbursement or payments) of a business for the
immediate period ahead, often 1 year or 18 months.
• Cash flow budget is used by managers in planning
their credit needs and repayment schedules, and to
anticipate their monthly cash productive balance.
4. Breakeven budget:
• This is an estimate of an uncertain item eg. yield or
price of produce that will make the farmer break even.
• It is used for the estimation of a feasible yield or

price in times of uncertainty about yields and prices.
5. Capital Budget/Investment Analysis:
• It is a projection of future earnings and costs for

investing in a capital asset; e.g. building,
machinery, irrigation schemes, etc.
• It provides information that enables the choice

between alternative investments or decision on
capital investment.
Construction of Complete Budget
• The procedure for constructing a complete budget
involves the following steps:
1. List all available resources

2. Estimate crop areas and livestock numbers
3. Estimate the physical inputs and outputs
4. Estimate the input and product prices
5. Estimate fixed costs (e.g. regular labour,
machinery, rent and general overhead)
6. Prepare layout and calculate expected profit
Construction of Complete Budget (cont’d)
• The gross margin approach is used in computing the
expected profit.
• This means:
i. constructing gross margin per hectare for each
enterprise, or gross margin per head, stating all
assumptions clearly.
ii. multiplying the gross margin per ha (or head) by
number of hectares (or heads) under each
enterprise to obtain the enterprise gross margin;
iii. summing up the enterprise gross margins to
obtain the total or whole farm gross margin; and
iv. subtracting fixed (or common) costs from whole
farm gross margin to obtain the net farm income.
• Suppose a 10–Hectare farm has 3 enterprises made

up of 2 hectares of cotton, 7 hectares of maize and
1 hectare of groundnut.
• The gross margin per hectare is first calculated for

cotton, maize and groundnut separately, and the net
farm income calculated as follows:
• Example of Gross Margin Approach

Cotton Maize Groundnut Total
Gross output/Ha 450 340 300
Total variable cost/Ha 300 230 180
Gross margin/Ha 150 110 120
Area (Ha) 2 7 1 10
Total Enterprise Gross Margin (¢) 300 770 120 1,190
Whole Farm Gross Margin (¢) 1,190
Common Cost (¢) 186 140 124 450
Net Farm Income (¢) 740
• This is a summary of the whole farm budget.

• Major assumption about yields and prices must be

stated clearly by including rates of input
application and related prices.
• Such assumptions can then be discussed, accepted

or rejected by others.
Construction of a Partial Budget
• Three types of changes in existing plan are possible in
partial budgeting:
1. Product (or enterprise) substitution (e.g. introduce yam and

reduce level of cassava or eliminate cassava).
2. Input substitution (e.g. increase the quantity of labour and

reduce the quantity of capital)
3. Change of enterprise level without substitution
(i.e. change in level of an existing enterprise without

affecting the level of other existing enterprises, but
involving the use of additional resources, e.g. increasing
area under yam without affecting area under cassava).
Construction of a Partial Budget (cont’d)
• Partial budgeting is a marginal analysis technique.
• It looks at the gains and losses due to changes in costs
and receipts and, therefore, the net effect on farm
income (which is likely to result from a marginal
change in the farming system).
• There are four basic components of partial budget

relating to gains and losses made:
1. What new revenues are made?
2. What existing revenues are lost?
3. What new costs are associated with change?
4. What existing costs are saved?
• The revenue and cost changes obtained are
grouped as gains and losses (not income
expenditure). The net effect is either a net gain or
a net loss.
• If the net effect is a net gain, it implies that the
change will be profitable. The format is presented
below:
Gains Losses
1. New revenue 2. Revenue lost (or foregone)
4. Costs saved 3. New costs

• The format may be presented as:
Net loss (if gains are less) Net gain (if gains are more)
• Example: Substitution of 1 Hectare of Tobacco for

1 Hectare of Maize
• Suppose a farmer plans to reduce his maize area by 1

hectare and substitute with a hectare of tobacco.
• He will have to hire more casual labour to cope with

harvesting of tobacco and building of curing barns for
tobacco.
• Details of returns and costs for maize and tobacco are

as presented in the following Table:
Maize Tobacco
Yield per ha. 36 bags 900 kg
Selling price ¢85 per bag ¢5 per kg
Seed rate 25 kg per ha -
Seed price 5 per kg. -
Fertilizer requirement 5 bags per ha 7 bags per ha.
Price of fertilizer ¢30 ¢30
Cost of fumigants for storing 1 hectare ¢10 -
Casual labour ¢50 ¢100
Depreciation on barns - ¢60
Seedlings - ¢50
Gains ¢ Losses ¢
1. New revenue from tobacco 4,500 2. Revenue lost (or foregone)
from maize 3,060
4. Costs saved: 3. New costs:
Fertilizer on maize: 150 Casual labour 100
Maize seed 125 Depreciation 60
Fumigant 10 Fertilizer on tobacco 210
Casual labour on maize 50 Seedlings 50
Net gain 1,355

Total 4,835 Total 4,835
• This implies that the change will be profitable, since

the net effect is a net gain of ¢1,355.
• For very small net effects, the farmer needs to rely on

his perceptions on future prices of the products.
CONTROL
What is Control?
• Control is the element of management that provides for a feed back
of information as the plan is executed.
• Control process involves:

i. preparing a plan or budget regularly,
ii. comparing actual results with it,
iii. identifying and explaining variations quickly; and
iv. taking remedial action, whenever variations are serious.
• Therefore, the control process consists of:

1. Explaining the difference between actual results and the budget
2. Assessing the need to depart from or return to present plan,
3. Taking suitable action.
Plan Actual
• The variation: is it serious?

Types of Control
Types:
i. Financial Control
ii. Operational Control
iii. Budgetary control
• Financial Control: relates to the control of monthly sales

and expenditure (i. e. cash flow situation).
• An effective financial control provides prompt management

information in the form of financial statements, cash flow
budgets, progress reports, etc.
• Operational Control: A mechanism for monitoring work

done in relation to the overall plan and orders given
Types of Control (cont’d)
• Budgetary control: it is the setting of goals or targets of
performance and the comparison of actual results with these
goals on a timely enough basis for remedial action to be
taken.
• The stages in budgetary control are:

1. Identifying and quantifying the differences (or variation)
between actual performances and plans or budgets
(i.e. variances: Actual – planned)
2. Analysing the variances – This involves sharing the

difference between actual results and budget forecast
among the sources of variation (i.e. plan or farm size,
quantity (yield or use) and price)
Why is control necessary?
• An effective control system
1. Measures actual performance for comparing with
plans to identify variations for remedial action where
necessary;
2. Ensures that plans are successfully executed. An

ideal plan is of no use unless it is executed
successfully.
3. Provides a guide to the manager on what action, on

his part, is needed to correct a problem (if any)
before it becomes serious.
Why is control necessary (cont’d)
4. Financial Control ensures that:
i. assets are properly protected and fully used;
ii. transactions are correctly recorded; and
iii. financial position is correctly presented at suitable
intervals.
5. Operational Control ensures that the actual work

done closely follows the overall plan (and orders
given) for a smooth and successful operation.
Note: The purpose of operational control is to make

the process go smoothly, properly and according to
high standards.
Variances
Concept
• Variance is the difference between actual performance and
plan or budget i.e. Actual - Plan
• If actual results are better than planned, a favourable variance

exists. If below standard an adverse variance exists.
• Therefore, variances highlight those situations where actual

results are not the same as planned – either better or worse.
• Variance could be due to inefficient use of input (resulting

from poor handling or wastage), poor quality of materials and
supervised staff; poor bargaining power, inflation or theft
Types of Variance
• There are two main types:
i. Cost variance, and ii. Output (value) variance.
• Cost variance is the deviation of actual cost from the

budgeted cost, while output variance is the deviation of
actual income from budgeted income.
Variance
Cost Output (value) variance

variance
Material Material use Price Yield

price variance variance variance
variance (qty of use variance) (qty of sales variance)
Types of Variance (cont’d)
• Material use variance will measure the difference between
actual quantity of material used (e. g. fertilizer/seed) and the
quantity budgeted for.
• It may show that the extra material cost is due to inefficient

use of input (not a higher price).
• In this case there is a responsibility on the supervisor in-

charge of the particular job where the inefficiency occurred.
Material price variance will measure the difference between

actual price of material used (e. g. fertilizer/seed) and the
expected price.
• Example of Adverse Material Use Variance:
Suppose it was estimated to use 500kg fertilizer per ha at
¢60/50kg but actually used 600 kg per ha at ¢60/50kg.
Solution:
• Estimated (or budgeted) cost = ¢600/ha
• Actual cost = ¢720/ha
• Material cost variance (Actual-planned) = 720 – 600

= ¢120 Adv.
• This is an adverse use variance or an unfavourable variance

and implies an inefficient use of input.
• This can be illustrated in a box diagram as below:
• Box diagram Illustration of Material Use Variance
¢
60
50 Adverse use variance
40 (100kg at ¢60/50kg = ¢120)

Price/
A
50kg 30
20
10
100 200 300 400 500 600 kg

Quantity of fertilizer/ha
• Example of Favourable Material Price Variance
• Suppose it was estimated to use 500kg fert/ha at
¢60/50kg but actually used 500kg/per ha at ¢50/50kg.
• Solution:
• Estimated cost: 500kg @¢60/50kg = ¢600
• Actual cost: 500kg @ ¢50/50kg = ¢500
• Difference: Actual-planned = 500-
600 = -
¢100 Fav
• Box diagram Illustration of Material Price Variance
Favourable price variance of ¢100

¢
60
B
50
This is a favourable price variance of
40 ¢100 shown as area B. It is favourable
Price/ as the actual result falls inside the
50kg 30 estimated.
20
10
100 200 300 400 500

Quantity of fertiliser (Kg)/ha.
• Combined Adverse Use and Favourable Price
Variances
• Suppose it was estimated to use 500kg fert/ha at
¢60/50kg but actually used 600kg/per ha at
¢50/50kg.
• Estimate: 500kg/ha @ ¢60/50kg = ¢600/ha

• Actual: 600kg/ha @ ¢ 50/50kg = ¢600/ha
• Cost variance: Actual – planned = 0
• Box diagram illustration
A is adverse use = 100 x ¢50/50kg = ¢100

B is favourable price = 500 x -¢10/50kg = - ¢100
¢ Sum = 0
60
B In this case, there is no material cost
50 variance as the use and price sub-
variances exactly balance each
40 other, so areas A and B are equal.
Price/
A
50kg 30
20
10
100 200 300 400 500 600

Quantity(kg) of fertilizer/ha
• Combined Adverse Use and Adverse Price
Variances
• Suppose we estimate using 500kg fert/ha at
¢60/50kg but actually used 600kg fert/ha at
¢70/50kg.
Estimate : 500kg fert./ha @ ¢60/50kg = ¢600

Actual : 600kg fert./ha @ ¢70/50kg = ¢840
Cost variance = ¢240
• Box Diagram Illustration
¢
70
B C
60
50
40
Price/
A
50kg 30
20
10
100 200 300 400 500 600

Quantity of fertilizer/ha
Area A = adverse use variance of 100 x ¢60 /50 = ¢120.00
Area B = adverse price variance of 500 x ¢10 /50 = ¢100.00
Area C = combination of both A & B 100 x ¢10/50= ¢ 20.00
Total cost variance =
¢240.00
Analysis of Variances
• This is the technique used to check in detail where
results actually vary from the budget.
• Each cost or output variance is further broken down

into differences due to plan (or size), quantity and
price.
• Thus output variance may be shared among plan,

yield and price; and cost variance among: plan, use
rate and price.
The total output plan share quantity share price share

variance = variance + variance + variance
i. Plan differences relate to changes in size of
enterprise (ha or heads).
• If a farmer plans to grow 10 ha of maize but he

grows 16 ha (or he plans to have 90 cows and in
practice he only keeps 70) there will be a plan
difference of 6 ha (or 20 cows).
Plan share of Plan Actual Actual

variance = Difference x yield x price
ii. Quantity differences relate to changes in yield or
use.
• A maize farmer who budgets for a yield of 20

bags per ha but harvests 20.5 bags experiences a
quantity difference of 0.5 bag.
Quantity quantity Budgeted Actual

share = Difference x plan x price
(iii) Price differences relate to changes in input and
output prices from time to time when budgets are
made and so influence results
e. g.
• There is a price difference of ¢40 per bag when
budgeted price is ¢75 per bag and actual price is ¢35
per bag.
Price Budgeted Budgeted

Price share = Difference x plan x yield
• Adverse Variances occur if one or more of the above

go wrong.
Example 1: Maize Output Variance
• Example 1: Maize OutputMaize
Plan (Ha) Variance Price Income (¢)
Yield (¢/bag)
(bags/Ha)
Budget 10 20 75 15,000
Actual 16 20.5 35 11,480
Difference +6 + 0.5 - 40 - 3,520
Share of 4,305 175 -8,000 - 3,520
Difference*
*Plan share = Plan Diff. x Actual yield x Actual price (6x20.5 x 35)
= 4,305
Yield share = Yield Diff. x Budgeted plan x Actual price (0.5 x10 x 35)
= 175
Price share = Price Diff. x Budgeted plan x Budgeted yield (-40 x 10 x 20)
= -8,000
Example 2: Feed Cost Variance
Plan Use Rate Price Expenditure

(No. of (kg feed/bird) (¢/50kg) (¢)
birds)
Budget 2,000 40 18 28,800
Actual 2,500 44 22 48,400
Difference + 500 +4 +4 19,600
Share of 9,680 3,520 6,400 19,600
Difference*
*Plan share = Plan Diff. x Actual use rate x Actual price = 9,680
Use share = Use Diff. x Budgeted plan x Actual price = 3,520
Price share = Price Diff. x Budgeted plan x Budgeted use rate = 6,400
Risk and Uncertainty
Risk and Uncertainty
• Risk and uncertainty are terms used interchangeably to denote the
occurrence of a future event for which the exact outcome is not
certain (or there is imperfect or incomplete knowledge).
Importance
Risks and uncertainties affect farmers’ decisions because realized
outcome is often different from what is predicted, and can result
in heavy losses if precautions are not taken to reduce variability
in the predicted and realized output.
Types and Sources of Risk and Uncertainty

• There are two main types of uncertainty, namely:
1. yield (or technical) uncertainty and
2. price (or market) uncertainty.

Types and Sources of Risk and Uncertainty (cont’d)
1. Yield (or technical) uncertainty: This refers to the

anticipation of the future on the variation in yield
even though the farmer uses the same inputs in one
time period as in another.
• The yields may be different because of differences in

weather conditions or disease and pest infestation.
• However, good management such as timeliness of

operations and early detection of pests and diseases
can do much to reduce yield variation.
2. Price (or market) uncertainty: It refers to the
anticipation of the future on the variation in the
prices of products and factors. The individual
farmer has no control over market prices.
• Prices to be realized vary in accordance with

a) actions of other producers/sellers,
b) fluctuations in national income and prosperity,
c) changes in consumer tastes, and
d) the vagaries of the weather.
Other Types of Uncertainty:

3. technological uncertainty,
4. legal uncertainty,
5. social uncertainty,
6. health uncertainty and
7. natural hazards.
• These (3-7) are factors which affect the two main
types and are, by themselves, subject to change
and hence constitute other types of uncertainty.
3. Technological uncertainty: Current technologies

and equipment may become obsolete (i.e.
outdated and inefficient) when new practices
follow with lower costs.
• Changes in technology alter the most profitable

combination of enterprises.
4. Legal uncertainty (or Legislation): The actions of

Government in formulating policies that affect
agriculture, particularly prices received for farm
products/factors cannot always be predicted.
Government policies on support prices, storage

programmes, production control, international trade,
etc. affect the prices received for farm products.
e.g. a total ban on the importation of certain primary

products (or crops such as rice) could affect the
domestic price.
5. Social (or sociological) uncertainty: The actions of others,
especially individuals with whom we do business cannot
always be predicted accurately.
• We cannot always predict the future actions of:
• the landlord, from whom we rent land;

• the neighbouring farmer, with whom we own a partnership
machine;
• the banker, who has lent us money, or
• the hired labourer, who works on our farm.
• While they may seem agreeable and cooperative, they may

become the opposite of our expectations.
• Often their own misfortune forces them to follow a
different course of action from what is originally
planned.
• Uncertainty attached to theft of farm products

(unauthorized harvesting), tools and equipment can
be considered under this category.
6. Health uncertainty (or Disabilities): Unexpected

tragedy such as sickness, injury, or death of a farmer
or his/her spouse or child can cause the family to
suffer undue hardship and, may be, sell the farm.
• Death can wipe away the most important

productive asset of the family – the life of the farm
manager and hence affect decisions.
7. Natural hazards (or Disasters): Drought or bad

weather, pests and diseases, fire, flood and hail
storms, etc. cannot be accurately predicted though
their occurrence causes a lot of loss in yield.
Reduction/control of risk and uncertainty
• The precautionary measures taken by farmers to

reduce or control risks and uncertainties include
the following:
1. Choice of reliable enterprises and production

techniques (i.e. enterprises and production
methods with low variability to reduce yield
uncertainty)
Reduction/Control of risk and uncertainty (cont’d)
2. Insurance (i. e. protection against loss by accepting to pay a
regular small annual cost to an organization for the
possibility of a large uncertain loss due to health and
natural hazards, etc.)
3. Diversification (of multiple production activities at the

same time, or production and sale of the same crop at
different times of the year to reduce yield and price
uncertainty) .
4. Contract agreements (with buyers of products and sellers of

input to reduce price uncertainty).
5. Maintaining flexibility in production (by keeping overhead

costs low in relation to total cost, or selecting enterprises
with relatively short production cycles)
Reduction/Control of risk and uncertainty (cont’d)
6. Maintaining adequate liquidity (by holding enough cash to
take advantage of favourable market situations)
7. Discounted returns or safety margins (by discounting future

prices, yields, and income, or subtracting margins)
8. Group action (to help set prices for produce, make bulk
purchases at reduced prices and ensure timeliness of farm
operations)
9. Studying price and market trends (for timing of sales at

different periods and locations)
10. Collecting more information on improved technology to be

able to make better decisions and reduce risk.
Practice Questions
• Identify the main sources/types of risk and uncertainty
encountered by farmers in your locality.
• What precautionary measures are taken by farmers in

your locality to reduce risk and uncertainty?
• What are some measures that you think your local or

national government can take to reduce risk and
uncertainty for farmers in your area?
• What strategies would you adopt for reducing the

effects of yield uncertainty?
THE END

AGEC 311 - Farm Management-1

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AGEC 311 - Farm Management-1

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Course Instructor: D. P. K. Amegashie

Office Location: Rm 8 Conference Building

Office Hrs: Mondays –Thursdays 2:30 – 4:30p.m.

2. BASIC MANAGEMENT CONCEPTS

• 5. ANALYSIS OF FINANCIAL ACCOUNTS

* Gross Margin Accounts

• 9. RISK AND UNCERTAINTY

• Plagiarism is ‘the presentation of the work or idea of

• In other words avoid taking credit for something that is not

• Continuous Assessment = 30%

• Note: There may be at least one unannounced

• Managers exercise their planning and controlling functions in four

• The field of management can be represented in a diagram as presented below:

• In farm management much emphasis is placed

• The general tendency today is to lay less stress on

• However, only few businesses and farmers aim

• This may be due to the several risks and uncertainties,

• In general, people engage in business in order to

• The most important of other objectives are:

1. High cash income (although profit is generally

2. High return on capital

3. Capital growth i.e. business expansion. It may be

- people may desire to own and use machines because a

- a breeding herd may be kept for the love of it or as a

6. Security: - Low but stable profits may be more

• It is concerned with getting the right things done

• The process of decision-making can be divided

(a) there is in fact a real problem to be solved, and

(b) the problem (if it exists) is not a combination of a

• There are usually several reasonable alternatives,

• Even “no change” is an alternative, which must

• The manager should assess the variations in future

• Examples of simple analysis would be :

- calculations from farm records of crops and animals,

- the calculation of figures for labour units per hectare,

• There are of course many other techniques of analysis

• Also, the effects which are hard or impossible to

• He can, however communicate to others what

• The steps or procedures involved in planning include

2. List the available resources and estimate the resource

4. Estimate the costs and returns for possible

5. Choose combination that gives the maximum

6. Prepare a long-term plan for land-use. E.g. farming

8. Prepare a plan for the marketing of produce (or

(nb. marketable surplus is the surplus of food

1. Resources are realistically appraised

2. Land use is well planned for production, fertility

3. Inputs are well estimated over the season or several

4. Financial changes are well anticipated, etc.

• This is the function by which performance is closely

• In the control process, actual results are regularly

• It also ensures that actual work done closely

1. Production: - Production management is especially

• Owing to seasonality of production, timing of jobs,

• It is also concerned with ordering inputs to best

• Good staff control will keep an adequate, but not excessive,

• However, the aim is to communicate with, train and motivate

• This requires decisions on:

• Knowledge of the market situation and trends, such as the

• Producers have an objective (or objectives), which they

• Many small farmers in the tropics lack managerial

• An able manager must be competent in both the