declining. The graph (Fig.16.

1) would illustrate the differences among the

Table 16.2 Estimation of Annual Depreciation using

Sum-of-the-Year-Digit Method
Year Value at the Annual Depreciation (Rs) Remaining
Beginning of the Balance
Year (Rs) (Rs)
1 12,000.00 (12,000-1,200) × 10/55 = 1,963.64 10,036.36
2 10,036.36 (12,000-1,200) × 9/55=1,767.27 8,269.09
3 8,269.09 (12,000-1,200) × 8/55=1,570.91 6,698.18
4 6,698.18 (12,000-1,200) × 7/55=1,374.55 5,323.63
5 5,323.63 (12,000-1,200) × 6/55=1,178.18 4,145.45
6 4,145.45 (12,000-1,200) × 5/55=981.82 3,163.63
7 3,163.63 (12,000-1,200) × 4/55=785.45 2,378.18
8 2,378.18 (12,000-1,200) × 3/55=589.09 1,789.09
9 1,789.09 (12,000-1,200) × 2/55=392.73 1,396.36
10 1,396.36 (12,000-1,200) × 1/55=196.36 1,200.00

Fig.16.1 D IFFER ENT M ETH O D S O F ESTIM A TIO N O F D EPR EC IA TIO N

3000
ANNUAL DEPRECIATION (Rs)

2500 Straight Line

M ethod
2000
Declining
1500 Balance M ethod

1000 Sum-of-the-
Year-Digit
M ethod
500

0
1 2 3 4 5 6 7 8 9 10
NUM BER OF YEARS OF LIFE

three methods of estimation of depreciation. The depreciation is higher in early

life of an asset, if it is estimated using sum-of-the-year- digit method than the
declining balance method. The amount of depreciation is constant throughout
the expected years of life of an asset, if it is calculated with straight-line
method.

b) Limitations of the Methods of Estimation of Depreciation

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 All the above methods of estimation of depreciation suffer from the following
limitations:

i) Some assets appreciate during the their early lives, E.g. livestock, but the
above methods do not provide any solution to this problem.

ii) The expected useful life of the asset and the expected junk value considered
might turn out to be quite different from the real life and the real junk value.
However, some adjustments can be made from year to year as more information
is gathered on these accounts. For instance, if the asset is wearing out at a faster
rate than the expected rate, the rate of depreciation may be increased. Similarly,
if higher junk value is expected than what was taken into consideration,
necessary adjustments to charge less depreciation may be made.

iii) If the machine is purchased as second hand, the number of years it has been
used and its original price may not be known. Then, the remaining years of life
has to be estimated and the depreciation has to begin from the purchase price.

iv) When the livestock is in a breeding stage or appreciation phase, revaluation

method will be more useful. But when they start depreciating, say, after three
years, as in the case of bullocks, straight-line method will be more appropriate.
v) Another major limitation is that these methods do not take into consideration
the market price changes during the life of the asset. The major purpose of
working out depreciation, in addition to charging the relevant costs to the farm
business during a particular year, is to provide allowances for replacing the
asset again at the end of its useful life. In situations of fast increasing prices,
some assets after their useful life can command a junk value above the value of
their original price. In such cases, revaluation method is more appropriate.

4.Revaluation Method: In the revaluation method, the asset is revalued every

year. The difference between the value of the asset at the beginning of a year
and the value at the end of the year is depreciation/appreciation, during that
year. Thus, it takes into consideration the appreciation of certain assets during
early years, avoids the problem of estimating the expected junk value and
considers the price effect. However, this method cannot be useful for all assets,
because many assets do not have readily available or reliable market prices.

b) Production Records
These records provide information on the input-output relationship of
different enterprises on the farm. These information are useful both for

193
measuring production efficiency and preparing efficient farm plans. Production
records have limited utility, as they do not indicate the financial position.

However, they show the quantity and time of application of various

resources to different enterprises on the farm and the yield and other physical
performance of different enterprises. Some of the popular physical records are:
a) Farm Map, b) Crop Records (season, crop and yield particulars), c) Livestock
Feed Record, d) Production Record of Livestock and e) Labour Records (to
study labour efficiency and seasonal requirement of labour).

c) Farm Financial Records

Farm financial records provide valuable information on economic efficiency
of the farm.

1) Cash analysis account book is the most important financial record to be

maintained by the farmer. The cash transactions, expenses and receipts, are
recorded in a cash analysis book as shown in table 16.3.

2) Trading Account: Trading Account is often used interchangeably with

“profit and loss account”. All the items in the cash analysis account book are
repeated in this trading account. Purchases and expenses are put on the left-hand
side and the sales and receipts on the right-hand side. Also, the closing
valuation is put on the right-hand side and the opening valuation on the left-
hand side. If the right-hand side total is greater than that of the left-hand, the
farm has earned profit. The profit is entered on the left-hand side but the loss on
the right-hand side. The trading account is prepared at the end of the year.

Table 16.4 Trading Account for the Year ending 31.06.2001

Purchases and Expenses Amount (Rs) Sales and Receipts Amount (Rs)

Opening Balance as on 1,10,000 i) Paddy 4,400

1-7-2000
i) Wages 3,400 ii) Sorghum 600
ii) Feeds 1,400 iii) Ground-nut 1,500
iii) Seeds 460 iv) Milk 4,560
iv) Fertilizers 1,340 v) Others 700
v) Rent 1,800 Closing Valuation 1,15,000
as on 30-6-2001
vi) Fuel 900 Total 1,26,760
vii) Others 700

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Total 1,20,000
Net Profit 6,760
1,26,760 1,26,760

195
 Table 16.3 Cash Analysis Account Book
(Amount in Rs)
Sales and Receipts Purchases and Expenditures

Total Paid

Fertilizers
Name and

Name and
Received

Oilseeds
Cereals
Details

Others

Details

Others
Wages

Feeds

Seeds
Total

Milk

Rent
Date

Date

Fuel
1-4-2000 Opening 11000 - - - - - Wages 3400 3400 - - - - - -
Balance

Paddy 4400 4400 - - - - Feeds 1400 - 1400 - - - - -

Sorghum 600 600 - - - - Fertilizers 1340 - - 1340 - - - -

Ground- 1500 - 1500 - - - Seeds 460 - - - 460 - - -

nut

Milk 4560 - - 4560 - - Rent 1800 - - - - 1800 - -

Others 700 - - - 700 - Fuel 900 - - - - - 900 -

Others 700 - - - - - - 700

Total 22760 5000 1500 4560 700 Total 10000 3400 1400 1340 460 1800 900 700

Closing balance in the bank (as on 31-3-2001) =Rs.22760 – 10000 = Rs. 12,760.

Opening balance as on 1-4-2001=Rs.12760.

196
3) Income Statement
Income statement indicates how well the farm business has performed during the
accounting period. From this, we can get an idea of the returns to various
resources after deducting the expenses and also about overall earnings of the
farm. This is an important financial record because it measures the financial
progress and profitability over a period of time. It is a summary of both cash and
non-cash transaction of the farm business. In non-cash financial transaction, we
get capital gain and depreciation. Income statement is divided into two major
categories, viz., income and expenses. Income includes cash receipts, capital
sales of business and changes in inventory value of items produced in the farm.
Expenses include operating and fixed expenses.

i) Inventory: It is a complete listing of all assets. Items like supplies, grain and
feed held for sale are listed on the inventory form.

ii) Capital Sales of the Business: The sale of milch animals and equipment are
major items under this heading. These types of receipts are separated from
normal cash receipts because they must be reported differently on tax forms.

iii) Changes in Inventory: In making adjustment for changes in inventory value,

both changes in price and quantity should be taken into consideration. If the
ending inventory value is greater than the beginning inventory value, it should
be treated as a form of income. If opposite holds true it should be considered as
negative income.

iv) Operating and Fixed Expenses: Operating expenses generally vary with the
size of the business operation. But fixed expenses do not significantly vary with
changes in volume of business done under the period of reporting.

4) Net Worth Statement

Net worth statement is also known as balance sheet. It is a summary of
assets, liabilities and owner’s equity (net worth) at a given point of time. This
statement shows the value of assets that would remain, if the farm business is
liquidated and all the outside claims against the business are paid. A business is
considered solvent, if the value of assets exceeds debt level. It is very useful for
the lender for scrutinizing the loan application. Net worth = Assets - Liabilities.

i) An asset can be defined as “anything of value in the possession of the farm

business or a claim for anything of value in the possession of others”. Farm

191
inventory, farm cash and accounts constitute the assets. Farm assets can broadly
be classified into the following three main categories.
Table 16.5 Income Statement (1st July 2000 to 30th June 2001)
(Amount in Rs)
Receipts Amount Expenses Amount
I Cash Receipts I Operating Expenses
1. Paddy sales 7,500 1.Hired labour 3,000
2. Sugar cane sales 5,500 2. Hired bullock labour 4,000
3. Ground-nut sales 12,000 3.Fuel and repairs for 2,500
machineries
4. Milk sales 6,500 4. Fertilizers 1,500
5. Broiler sales 12,000 5. Other crop expenses (seed 2,400
and spray of chemicals)
6.Miscellaneous 1,500 6.Livestock and veterinary 1,000
income (hired out expenses.
human and bullock
labour)
Sub-Total 45,000 7. Interest on current debt 600
II Net Capital Gain Income 8. Other miscellaneous 700
expenses
1. Sale of purchased 2,000 Sub-Total 15,700
milch animal
2. Sale of farm bred 2,000 II Fixed Expenses
animal
3. Sale of machinery 2,000 1. Land rent 3,000
Sub-Total 6,000 2.Land revenue, cess and 800
surcharge,
water charge, etc
III Change in Inventory Value 3. Land development 4,200
1.Crop inventory 4,000 4. Interest on intermediate 1,000
and long term loan
2. Livestock 1,000 5. Equipment depreciation 1,500
inventory
Sub-Total 5,000 6. Livestock inventory change 1,000
Gross Farm Income 56,000 7. Imputed value of family 1,000
labour
Net Farm Income 25,700 8. Building inventory change 600

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 9. Imputed value of operator’s 1,500
management
Sub-total 14,600
Total Expenses 30,300
Table 16.6 Net Worth Statement (as on 30th June, 2001)
(Amount in Rs.)
Assets Amount Liabilities Amount
I Current Assets I current Liabilities
1. Cash in hand 500 1. Cash expenses in seeds, 12,000
feeds, fertilizers, repairs, etc
2. Cash in bank 2,500 2. Interest on intermediate and 4,500
long term liabilities
3. Prepaid expenses for 2,500 3. Taxes 500
Goods not yet
Received)
4. Grains, seeds, feeds 25,000 4. Rent 2,500
and supplies
5. Cash investment in 5,000 5. That portion of 6,000
growing (standing) intermediate and long term
crops debt
Total-Current Assets 35,500 Total- Current Liabilities 25,500
II Intermediate Assets II Intermediate Liabilities
1.Machineries and 20,000 1. Sale contracts 2,000
equipment
2. Livestock 25,000 2. Intermediate or medium 16,000
term loan (balance due beyond
12 months)
3. Securities not readily 5,000 Total- Intermediate Liabilities 18,000
marketable
Total – Intermediate 50,000 III Long Term Liabilities
Assets
III Fixed Assets 1. Mortgage on land 12,000
1. Land (4 ha) 4,00,000 2. Land contract 5,000
2. Buildings 1,50,000 Total – Long Term Liabilities 17,000
Total – Fixed Assets 5,50,000 Total Liabilities 60,500
Total Assets 6,35,500 Net Worth =Total Assets – 6,35,500–
( I+II+III+) Total Liabilities 60,500 =
Rs.57500

a) Current Assets: Cash on hand or in the bank and other assets in the
possession of the farm, which may be liquidated in the normal operation of the
business like products held for sales and supplies are called current assets. The

193
liquidation of these items will have the least effect on the business to continue
its operation.

b) Working Assets or Intermediate Assets: Assets which are normally used up

during the life of the business such as farm equipment and machinery, breeding
and producing livestock can be categorized under this. They have the life of one
to ten years. The liquidation of these assets would have a significant influence
on business activity. These assets are somewhat more difficult to liquidate than
current assets.

c) Fixed Assets or Long Term Assets: Assets like land, building and land
improvements are difficult to convert into cash. They are long-term permanent
assets. These are not likely to be liquidated. If a major portion of these assets
were liquidated, the business would also be terminated in most cases. The sum of
current, intermediate and long-term assets is the total assets of the business. The
claim against is divided between debts of the business and owner’s equity (net
worth).

ii) Liability: A liability is defined as, “a claim by others against the farm
business, like mortgages and accounts payable”. Liabilities can be classified
into:

a) Current Liabilities: Liabilities, which call for immediate payment, generally

within one year and which cannot be deferred, are called the current liabilities.
They include rents, taxes and interest, plus that portion of principal on
intermediate and long-term debt due within the next twelve months.

b) Intermediate Liabilities: They are also known as medium term liabilities,

which can be deferred for the present. They are not of immediate concern but
have to be paid between one and ten year period.

c) Long-term Liabilities: Any deferred liability, which has to be met after ten
years and generally upto 20 years, is called the long-term liability. They consist
of mortgages and land contracts.

iii) Net Worth

Net worth is estimated by subtracting total liabilities from total assets. It

reflects the owner’s equity in the business and in other personal property. The
net worth statement is one of the primary documents used by lending agencies in

194
evaluating requests for new loans or extension of existing loans. It is also useful
for calculating financial ratios of the farm business.

B. SYSTEMS OF BOOK KEEPING

There are two systems of farm accountancy, namely, i) Singly entry system
and ii) Double entry system.

i) Single Entry System: This system ignores the double effects of transactions,
namely, receipts and payments. It is therefore, relatively imperfect. Its results
are less reliable and its accuracy cannot be tested by means of a trail balance,
which is possible under the double entry system alone.

ii) Double Entry System: Every transaction is recorded twice in the accounts,
i.e., to the debit side of one account and to the credit side of another. Each
category of assets, liability, expense and income will be allocated an account in
the ledger and this account will usually be divided into a debit (entry of a sum
owing) (left hand side) and credit (right hand side). Each transaction has a two
fold aspects of giving and receiving. The giving account is credited. The
receiving account is debited, i.e., receiving cash is debited. Giving goods (sales
account) is credited. In selling paddy for Rs 1200, there are two accounts, viz.,
cash account and paddy account. The cash account will be the receiving account
and hence the amount will be written on the debit side of it. The paddy account
will be the giving account; hence the amount will be written on the credit side of
it. One of the in-built checks of a double entry system in that a trial balance can
be prepared and the failure of the trial balance to balance credit and debit
indicates that there are errors in the accounts. Since every debit entry in a ledger
has a corresponding credit entry or entries, it follows that the total debit and
credit balances in the accounts must be also equal. The double entry system has a
number of advantages over other systems. They are as follows:

a) It can record all types of transaction.

b) Full information can be extracted quickly from the accounts at any time.

c) A check on arithmetical accuracy is built into the system.

A good farm record system should: i) be easy to keep; and ii) provide needed
information for analysis.

iii) Financial Ratio Analysis: The financial ratio analyses would useful to
assess the performance of the farm business.
195
 Total Assets 6,35,500
1. Net capital ratio = = = 10.50.
Total Liabilities 60,500
This is a measure of degree of financial safety over a period of time by
comparing the present position of the business with that on some previous date.
Higher the ratio, safer will be the position of the farmer.
Current Assets 35,500
2. Current ratio = = = 1.39.
Current Liabilities 25,500

It measures the ability of the farm to meet its current liabilities. Higher the
current ratio, the greater the short term solvency.
Quick Assets 28,000
3.Acid test ratio = = = 1.10
Current Liabilities 25,500
Quick assets are defined as current assets excluding inventories. Acid test
ratio is also known as quick ratio, which is a stringent measure of liquidity. It is
based on those current assets, which are highly liquid, i.e., inventories are
excluded from current assets, as they are the least liquid component of current
assets.
Debt (Total Liabilities) 60,500
4. Debt - Equity Ratio = = = 0.11
Owner’s Equity or Net Worth 5,75,000
Lower the debt, the higher degree of protection enjoyed by the creditors. The
lower this ratio, the more desirable it is. It is also known as Debt to Net Worth
ratio. The net worth indicates the solvency of the business. But this is the
ultimate solvency rather than intermediate solvency. Ultimate solvency is meant
that total resources are equal to or greater than total liability, in case the entire
business is closed out and all the liabilities are met with. Net worth is greater
than zero, when business is solvent. When total liabilities are not covered by
total resources, the business is insolvent or bankrupt. The intermediate solvency
is meant the relationship between current liabilities and liquid assets, which can
be used to clear them off, if demanded.
Net Sales 43,300
5. Total Assets Turn-Over Ratio = = = 0.07.
Total Assets 6,35,500
This measures how efficiently assets are employed over all. It is similar to
output-capital ratio used in economic analysis. The higher their ratio, the greater
the turn -over of assets.
Net Income 25,700
6. Net Income to Total Assets Ratio = = = 0.04
Total Assets 6,35,500
196
 It also measures how efficiently the capital is employed. The higher this
ratio, the more sound the capital use on the farm.
Net Worth 5,75,000
7. Equity/Value ratio = = = 0.90.
Total Assets 6,35,500
Higher the ratio, better will be the financial position of the farm business.
C. FARM EFFICIENCY MEASURES
Efficiency is generally taken to mean the output input ratio without any
consideration of the quality either of output or input or both.
i) Crop yield index: It is a measure by which the yields of all crops on a given
farm are compared with the average yields of these crops in the locality. The
yield index is a convenient measure because it represents a combined index of
yields of all the crops on a farm. Average yield of the area for each crop is
obtained and then the corresponding yield figures of the farm in question are
Table 16.7 Estimation of Crop yield Index
Crop Area Yield / Total Per Ha Area Required at the
(ha) Ha on Production Average Regional Yield to
the Farm (Qtls) Yield in the Obtain the Total Farm
(Qtls) Region (Qtls) Production (Ha)
1.Paddy 10 39 390 45 8.67
2. Maize 6 24 144 10 14.40
3.Wheat 15 32 480 28 17.14
Total 31 - - - 40.21
used to work out the hectares needed to have the same production as actually
obtained on the farm, if area average yields prevailed. The total hectares
required, at area average yields, to have the existing level of production are
divided by the hectares on the farm to obtain the yield index. A figure greater
than 100 indicates that the farm in question is more efficient than an average
farm in the area. The crop yield index of the above farm is 40.21 / 31.00 × 100
=130 per cent. As the index is greater than 100, the selected farm is more
efficiently operated in terms of crop yields as compared to an average farm in
the area.

ii) System Index: This index is used for determining the rationality by which various
enterprises on a certain farm are combined. It is obtained by expressing the potential net
income per hectare on a farm as a percentage of the average standard net income per hectare
in the area, i.e.,
Potential Net Income per Ha on the Farm
System Index = 197 × 100
Average Standard Net Income per Ha in the Area
If the system index is more than 100, it indicates a higher level of efficiency in
combining enterprises on the farm in comparison to that by an average farm in
the area and vice versa. Therefore, the system index = (1000 / 900) × 100 =
111.11 per cent. However, major difficulty may be encountered in calculating
this index, when the selected farm grows crops which are not usually grown in
the locality.

Table 16.8 System Index

Crop Average Standard Net Area under Units Total Potential
Income per Hectare of of Enterprise on Net Income of
Enterprise in the Area (Rs) the Farm (Ha) the Farm (Rs)
1. Paddy 1,000 10 10,000
2.Maize 500 6 3,000
3.Wheat 1,200 15 18,000
Total 2,700 31 31,000
Average 900 - 1,000

3. Intensity of Cropping: The intensity of cropping measures the extent of the

use of land for cropping purposes during a given year. The gross cropped area is
expressed as a percentage of net cropped area.It is expressed as a percentage.
Actual / Gross Area Cropped
Cropping Intensity = × 100
Net Cultivated Area
4. Irrigation Intensity: The gross irrigated area is expressed as percentage of
net irrigated area.
Actual / Gross Irrigated Area
Irrigation intensity = × 100
Net Irrigated Area
5. Labour Efficiency: A productive man equivalency is the average amount of
work accomplished by one man in the usual eight hour day (man day). Given
below is a list of important measures of labour efficiency:
a) Crops acres per man or per man-year.
b) Livestock maintained per man or per man-year.
c) Gross profits per man or per man-year.

6. Machinery Efficiency: It is helpful in judging the accomplishment of the

farm machinery and equipment for making changes in their investment it
required. A list of some common measures of machinery efficiency is given
below:

198
i) Machinery and equipment cost per cropped acre: Only, total annual costs
are considered including repairs, fuel, depreciation, etc. in estimating the cost.

ii) Investment in machinery and equipment per crop acre.

The following are a few important cost ratios:

a) Operating ratio: It represents the proportion absorbed by operating

expenses out of the gross income and is calculated as:
Total Operating Expenses
Operating Ratio =
Gross Income
b) Fixed Ratio: This is calculated by dividing the total fixed costs by the
gross income.
Total Fixed Expenses
Fixed Ratio =
Gross Income
c) Gross Ratio: This ratio expresses the percentage of gross income absorbed
by the total costs and is calculated as:
Total Expenses
Gross Ratio =
Gross Income

Chapter 16: Questions for Review.

1.Fill up the blanks:
i) As depreciation continues, the serviceability and value of the asset .
ii) assets are difficult to convert into cash to meet any current
obligations.
i) ratio measures the degree of immediate solvency of the business.
ii) loan is a current liability.
v) Annual installment of a term loan is liability.
vi) method would be useful to estimate depreciation of long lasting
assets like buildings, fences, etc.
2.Define the following:
i) Depreciation.
ii) Labour Efficiency.
iii) Farm inventory.
iv) Assets and liability.
1. Write short notes on the following:
i) Balance Sheet and Income Statement.
ii) Different methods of book keeping.
i) Land use efficiency.
4.Answer the following:
i) Discuss in detail the different records maintained in a farm and enlist the
advantages and limitations of maintaining records.
199
ii) Explain different methods of valuation of farm assets.
iii) How farm inventory is important in farm business?
iv) Explain different methods of estimation of depreciation.
v) What do you understand by farm records? What are the objectives of keeping
farm records? Enlist and explain the various types of farm records.
vi) Distinguish between balance sheet and income statement. Explain the
different financial ratios. How these financial ratios are useful to assess the
financial strength of the farm business?
vii) Explain the different methods for improving the efficiency of farm labour.
iii) Explain the different farm efficiency measures you have studied.

FARM FINANCE

Farm finance has become an important input due to the introduction of

capital-intensive agricultural technologies. Farm finance can be defined as the
amount of funds obtained from off farm sources for use on the farm, repayable in
future with an interest agreed to either explicitly or implicitly. Agricultural
finance in the economic study of borrowing of funds by farmers, of the
organization and operation of farm lending agencies, and of society’s interest in
credit for agriculture.

A. FARM FINANCE

Farm finance is a crucial input for farm development. It is: i) not only meant
for more production but also to raise the productivity of farm resources; ii) not a
mere loan or advance, but it is an instrument to promote the well being of the
farming community; iii) not just a science to manage the money, but is an
applied science of allocating scarce resources to derive optimum output; and iv)
not a mere social obligation on the society, but it is a lever with backward and
forward linkages to the economic development both at the micro and macro
level.

i) Importance of Agricultural Finance

Credit is essential for agricultural development and also for the development
of the economy as a whole. The agricultural finance is required for the following
reasons:

200
1) The scope for extensive agriculture in India is limited. Therefore, increase in
agricultural production is possible only by intensification and diversification of
farming. Intensive agriculture needs huge capital.

2) Extreme inequalities exist in the distribution of operational holdings and

operational area. Seventy eight per cent of the total number of farm households
which own less than two hectares operate only 33 per cent of the total operated,
whereas only two percent of total number of farm households which own more
than 10 hectares each operate 17 per cent of the total operated area in 1990-91.
The purchasing power of these small and marginal farmers is limited due to their
subsistence farming. Hence, they have to depend on the external financial
assistance to use the costlier inputs.

3) Farmers’ economic condition is subject to frequent onslaught of flood,

drought, famines, etc. Therefore, either the continuance of cultivation of crops or
making improvements on the farms depends on the nature and availability of
finance.

4) In recent years, more area is brought under irrigation which in turn would
increase the use of inputs like fertilizer and plant protection chemicals. In order
to accomplish this, external finance is needed.

5) In order to sustain the development of agro-based industries, there should be a

substantial increase in the supply of raw materials needed for such industries.
Therefore, for the development of farm sector, a constant flow of credit is
essential and it would enhance overall growth of the economy.

6) In agriculture, fixed capital is locked up in permanent investments like land,

well, buildings, etc. More over, it takes a long time, i.e., gestation period, to get
returns from farm. Hence, farmers need finance to continue their farm
operations.

7) The weaker sections of the farming community should be motivated to

participate in development programmes by giving financial assistance to acquire
productive assets.

8) Small and marginal farmers are trapped in the vicious cycle of poverty i.e.,
low returns⇒low saving⇒low investment⇒low returns. To break this cycle,
credit has to be injected in agricultural sector.

201
9) External finance is necessary for helping the farmers to overcome distress
sales and market the produce in a better way. Regulated markets as well as
commercial banks are extending financial assistance, i.e., by advancing 75 per
cent of the value of the produce, to the farmers based on the warehouse receipt.
This enables the farmers to clear off their loans and dispose the produce at
remunerative prices.

B. FARM INVESTMENT ANALYSIS

Investment refers to the addition of durable and income generating permanent

asset to a business. Financing refers to the means of acquiring control of assets’
ownership by cash purchase or borrowing, leasing and custom hiring. Clearly, an
investment can be financed in several ways and each may affect its profitability
and risk. The following question has to be answered in making decisions
regarding investment on farms.

i) Why investment analysis is a difficult job?

Farm investment analysis is difficult because of the following reasons:

a) Farmers are having limited resources.

b) Resources have alternate uses.

c) Different uses have different pay-offs.

d) Different uses have different project lives.

There is a need to make choice before making investment. So, job is made
difficult in selection of choice.

ii) Investments have four characteristics in general. They are:

a) Point input and point output E.g.) Casurina.

b) Point input and continuous output E.g.) Digging a well, land reclamation and
development.

c) Continuous input and point output. E.g.) Sheep/Goat rearing.

d) Continuous input and continuous output. E.g.) Plantation crops, orchard crops,
perennial crops.

202
 Farm investment analysis is used to determine attractiveness of additional
investment in the farm, while farm income analysis is generally used to evaluate
the performance of a farm in a particular year. Farm investment analysis is
undertaken to determine the attractiveness of a proposed investment to farmers
and to other participants, including the society as a whole. It projects the effect
of a particular investment on farm income and estimates the return to the capital
engaged. The analysis is projected over the useful life of the investment. This
analysis concentrates on how the time can be incorporated into decision-making
process when compared with different periods of productive use.

iii) Steps in Investment Analysis: The following steps are involved in the
investment analysis:

a) A search for profitable investment opportunities: A search for profitable

investment alternatives is an important step. Some investment opportunities are
obvious and require little effort for searching, such as the need to replace worn
out parts of tractor or farm equipment. Farm investment opportunities generally
include one of the following categories:

1) Maintenance and replacement of depreciated capital items.

2) Adoption of cost reducing technology.

3) Expansion of output in existing enterprises and

4) Expansion of output through the addition of new enterprises.

b) Determining the capital requirement: The cost of initial investment and

operation and maintenance cost over economic life of capital constitute the
capital requirement.

c) Computation of cost of capital, which takes into account the availability of

funds: In capital budgeting or investment analysis, a discount rate, which is the
cost of capital, is selected. This discount rate is a required rate of return from an
investment to the farmer. As such, discount rate is the opportunity cost of the
investment to the farmer. That is, the opportunity cost of capital for any
investment alternative is the rate at which the capital can earn in its next best
alternative use. Usually, for convenience, the interest rate offered by credit
institutions (12 per out per annum) is taken as discount rate.

d) Method for recognizing future cash follows and the time value of money.
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Time value of money: Interest rate serves as the pricing mechanism for the time
value of money and reflects an investor’s time preference for money. The rate
(i) is considered an exchange price between present and future cash flows. Thus,
rupee 1 today exchanges for (1+i) rupees at the end of period 1 in future. Or,
alternatively, one rupee payment made in period 1 in the future exchanges for
1/1+i rupees now. Compounding is the process of finding future value of present
amount.

FV= Present value × (i + interest rate) number of years. That is, FV= PV (1+i)n ,
where, (1+i) is the compounding factor. Discounting is the process of finding the present
value of future cash flow account.

Future value FV
Present Value (PV)= =
(1 + interest rate) number of years (1+ i)n

e) The effects of time and interest rate on present and future values: The important
variables determining present and future values of a single payments or a series of payments
are i) the number of conversion periods (project period) and ii) the size of interest rate per
year. Both factors interact to determine the total effects of discounting or compounding on
present or future values. At low rates of interest, the number of years has only a little effect
on either present or future values.

There are two measures to assess the worthiness of an investment, viz., 1)

undiscounted and 2) discounted measures.

1) Undiscounted Measures

Here, the cash flows of the investment are not discounted to estimate the
present worth of future stream of cash flow. There are four major methods in
undiscounted measures as discussed below:

i) Ranking by Inspection: We can tell that by simply looking at the investment

cost and stream of net value of incremental production that one project should be
accepted over another. Here, we have two instances: i) with the same investment,
two projects produce the same net value of incremental production for a period,
but one continues to earn longer than the another (we would choose Project II
rather than Project I). ii) For the same investment, the total net value of
incremental production may be the same, but one project has more of the flow
earlier in the time sequence (we would choose Project IV rather than Project III).
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However, we cannot tell by inspection, whether Project IV would be preferred to
Project II, as it requires more elaborate analysis.

ii) Pay back period: Pay back period is the length of time from the beginning of
the project until the net value of the incremental production stream reaches the
total amount of the capital investment. Both Projects I and II have the same pay
back period of three years, but we know by inspection that Project II will
continue to return benefits in the third year, whereas Project I will not. The
weakness of the pay back period as a measure of investment worth is that it does
not take into consideration the timing of proceeds.

Table 17.1 Four Hypothetical Pump Irrigation Projects

(Amount in Rs.)
Year Incremental cost Value of Net Value of
Capital Operation Produ Gross Incremental Incremental
Items and -ction Cost Production Production
Mainten- (Gross (Net Income)
ance Income)

Project I
1 30,000 - - 30,000 - -

2 - 2,000 3,000 5,000 20,000 15,000

3 - 2,000 3,000 5,000 20,000 15,000

4 - - - - - -

Total 30,000 4,000 6,000 40,000 40,000 30,000

Project II
1 30,000 - - 30,000 - -

2 - 2,000 3,000 5,000 20,000 15,000

3 - 2,000 3,000 5,000 20,000 15,000

4 - 2,000 3,000 5,000 9,100 4,100

Total 30,000 6,000 9,000 45,000 49,100 34,100

Project III
1 30,000 - - 30,000 - -

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 2 - 2,000 3,000 5,000 7,000 2,000

3 - 2,000 3,000 5,000 19,000 14,000

4 - 2,000 3,000 5,000 31,000 26,000

Total 30,000 6,000 9,000 45,000 57,000 42,000

Project IV
1 30,000 - - 30,000 - -

2 - 2,000 3,000 5,000 7,000 2,000

3 - 2,000 3,000 5,000 31,000 26,000

4 - 2,000 3,000 5,000 19,000 14,000

Total 30,000 6,000 9,000 45,000 57,000 42,000

Table 17.2 Pay back period

Project Pay Back Period (Years) Rank

I 3.0 1
II 3.0 1
III 3.5 4
IV 3.1 3

iii) Proceeds Per Unit of Outlay: Here, the total net value of incremental
production is divided by the amount of the investment. Here, we find that
Projects I and II are correctly ranked. But Projects III and IV receive equal
rank, although we know by simple inspection that we could choose Project IV
Table 17.3 Proceeds Per Unit of Outlay
Project Incremental Total Net Value of Proceeds per Rank
Cost (Capital Incremental Production unit of
Items) Outlay
I 30,000 30,000 1.00 4
II 30,000 34,100 1.14 3
III 30,000 42,000 1.40 1
IV 30,000 42,000 1.40 1

because its returns are received earlier. Here, again, the criterion of proceeds
per unit of outlay fails to consider timing; money to be received in the future
weights as heavily as money in hand today.

206
iv) Average Annual Proceeds per Unit of Outlay: The total of the net value of
incremental production is first divided by the number of years it will be realized
and then this average of the annual proceeds is divided by the original outlay for
capital items. By failing to take into consideration the length of time of the
benefits stream, it automatically introduces a serious bias toward short-lived
investments with high cash proceeds. Project I ranks much better than Project II,
although we know by simple inspection that Project II is the project we would
choose. Similarly, the criterion cannot choose between Projects III and IV,
although again by inspection, we know that we would prefer Project IV because
it returns its benefits earlier. All these four measures fail to take into account
adequately the timing of the benefit stream. Therefore, discounting technique is
used to estimate the present worth of future returns so as to assess the financial
worthiness of a project.

Table 17.4 Average Annual Proceeds per Unit of Outlay

Project Incremental Net Value of Average Net Average Rank
Cost Incremental Value of Annual
(Capital Production Incremental Proceeds per
Items) Production unit of Outlay
I 30,000 30,000 15,000 0.50 1
II 30,000 34,100 11,367 0.38 4
III 30,000 42,000 14,000 0.47 2
IV 30,000 42,000 14,000 0.47 2

2. Discounting Measures
The discounting is based on the principle that the present values are better than the same

values in the future, and earlier returns are better than that of the later. Discounting is

essentially a technique by which one can “reduce” future benefit and cost streams to their

“ present worth”. The basic idea underlined in the discounted measures is that money has

a time value. As the money can be put into alternative uses, it has an opportunity cost.

The value per unit of money is higher today than at any future point of time. That is why,

interest is paid on borrowed funds. Thus, an individual’s preference for money through

time is called time preference. Once the individual decides to invest rather than spend, to

become an entrepreneur rather than a consumer, he should never accept less than the

207
 market rate of interest. The interest rate used to discount or compound sums of money

should be at least as large as the current market rate of interest, which can be taken as

opportunity cost of capital. In order to evaluate the profitability of investment, three

discounted measures are available, viz., i) Net Present Worth (NPW), ii) Benefit -Cost

Ratio (BCR) and iii) Internal Rate of Return (IRR).

i) Net Present Worth: Net Present Worth is often referred as net present
value. The present worth of the net benefits of a project is obtained by
deducting costs from the benefits and the resulting net benefits are discounted at
the opportunity cost of capital for each year. The sum of the net benefits during
the life period of the project gives the net present worth. If the NPW is positive,
then it is construed that the project is economically feasible. If the NPW is zero,
it means that the cost of the project has been fully recovered at the rate of
discounting. Mathematically, it can be represented as:
n Bt - Ct
NPW = Σ
t =1 (1+i) t
Where, B t = Benefits in each year; C t = costs in each year; n= number of years
(plan horizon) (Economic life is normally considered). The economic life of an

investment project represents the length of the life, the investor intends to hold
the assets required. It does not represent the service life of the asset or the time
taken to wear-out); i= interest (discount) rate; and t = time period- 1, 2, ..., n
(number of years).
Present Worth of Benefits
Benefit-Cost Ratio = ii) Benefit Cost Ratio: It is widely used
Present Worth of Costs
as measure of social benefit. It is the
Mathematically, it can be represented as,
n Bt ratio between the present worth of
Σ benefit and present worth of costs. In
t =1 (1=I)t order to compute the benefit - cost ratio,
Benefit- Cost Ratio =
n Ct the opportunity cost of capital may be
Σ used as a discounting rate. The salvage
t =1 (1=I)t

value of the asset (at the end of its life time), if any, should be treated as a benefit in the last
year of the project. The ratio is computed not by discounting the gross costs and gross

208
benefits over the life time of the project; but by discounting costs and benefits each year. If
the BC ratio is greater than one, the project is worthy of investing.

3. Internal Rate of Return (IRR): The internal rate of return is defined as that
rate of discount which makes the present worth of benefits and costs equal or
just makes the net present worth of the cash flow equal to zero. This measure is
popularly used in economic and financial analysis. All projects having an
internal rate of return above the opportunity cost of capital are selected for
making investment. It is a measure of the earning capacity of a project. The
internal rate of return can be mathematically presented as:
n Bt - Ct
Internal Rate of Return = r Σ = 0 ; i.e., NPW = 0
t
t =1 (1+i)
r = internal rate of return.

The IRR is calculated generally on a trial and error basis, using alternative
rates of discount, till the NPW of the project reaches zero. To start with, the cash
flow is to be discounted by opportunity cost of capital. If this net present worth
of the cash flow is found to be positive, then, the cash flow has to be further
discounted by raising the discount rate, till the net present worth of cash flow
becomes negative. Practically, it is very difficult to compute the real IRR and
hence interpolation method is used to estimate the true value of IRR.

Lower Discount Difference Present Worth of Cash Flow at Lower

Rate (at which Between the Discount Rate.
the NPW is + Lower and Absolute Difference Between the
IRR = Positive) Higher Present Worth’s of the Cash Flow at
Discount Rates the Lower and Higher Discount Rates
(Signs Ignored)

Problem: A farmer wants to purchase a power tiller at Rs. 60,000. The annual
cost of maintenance and returns for the power tiller are estimated at Rs. 14,200
and rs.26,300 respectively. Its junk value is Rs.6,000. Advise the farmer about
the financial worthiness of the purchase of power tiller using NPW, BCR and
IRR (the opportunity cost of capital is 12 per cent per annum).

Table 17.5 Estimation of NPW, BCR and IRR

209
 Year Cost Benefit Net Present Present Present Present
Benefit Worth of Worth of Worth of worth of
Cost @12 Benefit@ Net net benefit
% 12 % Benefit @16%
Discount Discount @12 % discount
Rate Rate dis.rate rate
0 60000 - - 60000 60000.00 - 60000.00 60000.00
1 14200 26300 12100 12678.57 23482.14 10803.57 10431.03
2 14200 26300 12100 11320.15 20966.20 9646.05 8992.27
3 14200 26300 12100 10107.28 18719.82 8612.54 7751.96
4 14200 26300 12100 9024.36 16714.13 7689.77 6682.72
5 14200 26300 12100 8057.47 14923.33 6865.86 5760.97
6 14200 26300 12100 7194.16 13324.40 6130.24 4966.35
7 14200 26300 12100 6423.36 11896.78 5473.42 4281.34
8 14200 26300 12100 5735.14 10622.13 4886.99 3690.81
9 14200 26300 12100 5120.66 9484.04 4363.38 3181.73
10 14200 32300 18100 4572.02 10399.74 5827.72 4102.97
Total 140233.17 150532.71 10299.54 - 157.85

Net Present Worth = Rs. 10,299.54

150532.71
Benefit – Cost Ratio = = 1.07
140233.17
10299.55
IRR = 12 + 4 = 15.94 per cent.
10457.40

Chapter 17: Questions for Review.

1.Fill up the blanks:
i) The discount rate is used as the cost of the farm investment to the
farmer.

ii) Discounting and compounding are influenced by and .

iii) The undiscounting measures fail to consider the of the benefit

stream.

ii) A project is considered to be financially feasible if its IRR is greater than the

2.Define the following:

i) Farm finance.

210
ii) Agricultural finance.

iii) Farm investment analysis.

iv) Discount rate.

v) Pay back period.

vi) Plan horizon.

vii) Net Present Worth.

viii) Benefit Cost ratio.

ix) Internal Rate Return.

3.Write short notes on the following:

i) Characteristics of farm investment.

ii) Discounting and undiscounting techniques.

4.Answer the following:

i) How agricultural finance is important for farm development?

ii) How farm investment analysis is useful in decision-making?

iii) Explain the steps involved in farm investment analysis.

iv) How discounting techniques are superior over the undiscounting

techniques?

v) Explain the different discounting techniques you have studied and explain
how they are useful in farm investment analysis.

FARM PLANNING AND BUDGETING

A. FARM PLANNING

Farm planning is a decision making process in the farm business, which

involves organization and management of limited resources to realize the
specified goals continuously. Farm planning involves selecting the most
profitable course of action from among all possible alternatives.

i) Objectives of Farm Planning

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 The ultimate objective of farm planning is the improvement in the standard
of living of the farmer and immediate goal is to maximize the net incomes of the
farmer through improved resource use planning. In short, the main objective is to
maximize the annual net income sustained over a long period of time. The farm
planning helps the cultivator in the following ways:

a) It helps him examine carefully his existing resource situation and past
experiences as a basis for deciding which of the new alternative enterprises and
methods fit his situation in the best way.

b) It helps him identify the various supply needs for the existing and improved
plans.

c) It helps him find out the credit needs, if any, of the new plan.

d) It gives an idea of the expected income after repayment of loans, meeting out
the expenditure on production, marketing, consumption, etc.

e) A properly thought of a farm plan might provide cash incomes at points of

time when they may be most needed at the farm.

A farm plan is a programme of total farm activities of a farmer drawn out in

advance. An optimum farm plan will satisfy all the resource constraints at the
farm level and yield the maximum profit.

ii) Characteristics of a Good Farm Plan

A good farm plan generally should have the following characteristics:

a) An element of flexibility in a farm plan is essential to account for changes in

the environment around the farm.

b) A farm plan should maximize the resource use efficiency at the farm.

c) It should provide for the attainment of the objectives of profit maximization

through optimum resource use and balanced combination of farm enterprises.

d) Risk and uncertainty can be accounted for in a good farm plan.

e) The plan helps in timely acquisition and repayment of farm credit.

iii) Components of Farm Planning: Any systematic farm planning necessarily

has the following five components:
212
a) Statement of the objective function: Many farmers aim at profit
maximization. However, some farmers do not go all out to maximize their
profits, but have objectives like cereal requirements for the family and fodder
needs for the livestock.

b) Inventory of scarce resources and constraints

1) Land: Location, topography, soil type, fertility, drainage, irrigation systems

and so on affect enterprises in many ways and hence, it is useful to divide all the
land on a farm into different enterprises.

2) Labour: On subsistence farms, all labour is supplied by the farmer and his
family. Thus, it is important to record the number of workers - male, female and
children - and the type of manual work each is prepared is undertake. However,
in commercial farms, hired labour constitutes a major component of costs and
thereby inviting more attention in the planning process.

3) Capital: Whether fixed, like buildings and machines, or circulating, like cash
in hand or in the bank, capital acts as a very powerful constraint.

4) Personal: Farmers’ past experience, attitude towards risks and uncertainties

and personal likes and dislikes influence the choice of enterprise.

5) Institutional: Market often serves as a constraint for the production of

vegetables, poultry, milk, etc. Even if the location of the farm is suitable for a
particular crop (commodity), a contract may still have to be obtained. E.g.
Sugarcane growing near the sugar mills. Similarly, though many parts of
Himachal Pradesh are suitable for poppy cultivation, the government has banned
its cultivation.

6) Rotations: Maximum permissible area under a particular crop in a given

season or minimum area constraints imposed on the acre under some crops like
legumes would serve in maintaining soil fertility and help controlling pest and
diseases.

3) Alternative Choices: Alternative choices in planning refer to the various

enterprises, crops and livestock, which can be considered for attaining the stated
objectives. There are alternate ways to use the scarce farm resources. There may
be more than one ways to produce the same enterprise. A comprehensive list of
different alternative enterprises can be prepared.

213
4) Input Output Co-efficients: The requirements of each of the several scarce
resources and the financial returns per unit of each enterprise or activity need to
be considered here. The precision in planning depends more on accurate input-
output data than on the technique of planning.

5) Planning Technique: With a proper understanding of the planning

environment and use of precise input-output data along with true and realistic
constraints, sophisticated techniques give better results. However, common sense
in the planning process could lead to fairly good results. Some of the farm
planning techniques are as listed below:

1. Budgeting.

2. Linear Programming.

Budgeting is most informal of all the planning techniques and the level of
sophistication gradually increases as we move from budgeting to linear
programming.

iv) Steps in Farm Planning: The various steps involved in planning are
discussed below:

a) Planning: This includes the identification and definition of the problem,

collection of information, identifying alternative solutions and analyzing each
alternative. Planning is the basic management function as it means deciding on a
course of action, procedure or policy. The control function is a source of new
information, as the results of the initial plan become known.

b) Implementation: Once the planning process is completed, the best alternative

must be selected and action should be taken to place the plan into operation. This
requires the acquisition and organization of necessary land, labour, capital and
other inputs. An important part of the implementation function is the financing
of the necessary resources.

c) Control: This provides for observing the results of the implemented plan to
see if the specified goals and objectives are being met. Many things can cause a
plan to go “off its track”. Price and other changes, which occur after the
implementation of the plan, can cause the actual results to deviate from the
expected. Control requires a system for making regular checks on the plan and

214
monitoring progress and results as measured against the established goals. The
dashed line in the chart represents the continuous flow of information from the

PLANNING: Draw
Up Alternative Plans.

IMPLEMENTATION: Select A
Plan and Put it into Operation.

CONTROL: Analyse and Evaluate

Progress of Plan over Time.

YES Are Planning Objectives

Being Achieved?
No
Does the Remedy Lie Within No
YES
the Farmer’s Control ?

Chart.18.1 Steps in Farm Planning

control function back to planning, an important part of the total system. Without
some feedback procedure, the information obtained by the control system is of
no use in making corrections in the existing plan or improving future plans. This
feedback sets up a continuous cycle of planning, implementation, monitoring and
recording progress, followed by a reevaluation of the plan and the
implementation procedures using the new information obtained through the
control function.

B. BUDGETING

It may be defined as a detailed physical and financial statement of a farm

plan or of a change in farm plan over a certain period of time. Farm budgeting is
a method of analyzing plans for the use of agricultural resources at the command
of the decision-maker. In other words, the expression of farm plan in monetary
terms through the estimation of receipts, expenses and profit is called farm
budgeting.

215
i) Types of Farm Budgeting: The following are the different types of farm budgeting
techniques:

a) Partial Budgeting.

b) Enterprise Budgeting.

c) Cash flow Budgeting.

d) Complete Budgeting.

a) Partial Budgeting: This refers to estimating the outcome or returns for a part
of the business, i.e., one or few activities. A partial budget is used to calculate
the expected change in profit for a proposed change in the farm business. A
partial budget contains only those income and expense items, which will change,
if the proposed modification in the farm plan is implemented. Only the changes
in income and expenses are included and not the total values. The final result is
an estimate of the increase or decrease in profit. In order to make this estimate, a
partial budget systematically, answers to following four questions relating to the
proposed change: 1) What new or additional cost will be incurred? 2) What
current income will be lost or reduced? 3) What new or additional income will be
received? and 4) What current costs will be reduced or eliminated? The first two
questions identify changes which will reduce profit by either increasing costs or
reducing income. Similarly, the last two questions identify factors which will
increase profit by either generating additional income or lowering costs. The net
change in profit can be computed by estimating the total increase in profit minus
the total reduction in profit. A positive value indicates that the proposed change
in the farm plan will be profitable. All the changes in farm plan that can be
appropriately adapted with the help of a partial budget can be grouped into three
types. They are as given below:

1) Enterprise substitution: This indicates a complete or partial substitution of

one enterprise for another. E.g. substituting one acre of paddy for one acre of

sugarcane.

2) Input substitution: Changes involving the substitution of one input for

another or the total amount of input to be used are easily analyzed with a partial
budget. E.g. substituting machinery for labour.

216
3) Size or scale of operation: Included in this category would be changes in
total size of the farm business or in the size of a single enterprise. E.g. Buying or
renting additional land or machinery.

Table 18.1 Introduction of Soyabean as an Intercrop in Sugarcane

Debit (Added Cost) Amount (Rs) Credit (Added Return) Amount (Rs)
1. Increased Cost: 280.00 1. Added Return 1200.00
i) Labour
ii) Seed 20.00 2. Reduced Cost -
Sub- Total 300.00 Total 1200.00
2. Reduced Return -
Total 300.00
Net change in income=Added return – Added cost = Rs. 1200 – 300 = Rs. 900

i) Limitations of partial budgeting technique

1. Partial change does not always provide a complete solution.

2. The results of partial budgets are subject to variations in output - input

prices, availability of resources and variations due to soil type, soil fertility etc.

b) Enterprise Budgeting: Enterprise is defined as a single crop or livestock

commodity. Most farms consist of a combination of several enterprises. An
enterprise budget is an estimate of all income and expenses associated with a
specific enterprise and an estimate of its profitability. It is pre-requisite for the
preparation of a complete farm budget or for the application of farm planning
techniques like linear programming. An enterprise budget lists down all the
expected output, both in physical as well as value terms, for a unit of a particular
activity (i.e., per hectare, per animal or per 100 birds) on the farm. The
enterprise budget is important since it depicts the relative profitability of
different enterprises or activities or alternatives, which can be used to determine
the relative dominance of different enterprises. It includes variable cost or total
operating cost and fixed cost including depreciation and interest on fixed asset.
Any enterprise budget can also be analyzed in terms of cash versus non-cash

expenses and total cost versus actual cash outlay.

Table 18.2 Enterprise Budget for Irrigated Ground - Nut
Particulars Amount (Rs)
I Returns
217
1. Main product 6277
2. By product 524
3. Gross return 6801
II Cost
1. Land revenue 21
2. Seed 1245
3. Manures and fertilizers 530
4. Plant protection chemicals 98
5. Irrigation charges 190
6. Machine power 206
7. Bullock power 304
8. Human labour 1617
9. Interest on working capital 128
10. Depreciation on buildings and machineries 125
11. Interest on Fixed capital 725
Total cost 5189
Net return 1612

c) Cash - Flow Budgeting: It is essential to know about cash flow statement

before using the cash flow budgeting.

1) Cash Flow Statement: It summarizes the magnitude of cash inflows and

outflows over a period of time.

2) Importance of cash flow Statement: It helps to assess: i) whether cash would

be available in correct quantity at right time; ii) whether the surplus could be
profitably diverted and iii) timing and magnitude of borrowings required. The
cash flow statement may be constructed over annually, quarterly, monthly and
weekly depending upon the nature of business.

i) Cash inflows represent the amount of cash received during the particular time
period. It includes: a) the beginning cash balance, b) receipts through sales of
farm and non-farm assets and c) receipts of short term (operating), intermediate
and long term loans.

ii) Cash Outflows represents the expenses incurred in a given period of time. It
includes: a) Cash expenses (variable cash expenses, fixed cash expenses, non-
farm investment, and personal expenses), b) Repayment on operating (crop)
loans and c) repayment on intermediate and long-term loans.

Cash flow analysis indicates the amount of cash flowing into and out of the
farm business over a specific period of time. Cash flow statements and income
218
statements both show inflows and outflows of money, but differ in their
treatment of several important accounting entries. A cash flow statement
includes non-farm items such as income taxes, non-farm income and living
expenses and gives a complete accounting of debt transactions by showing
principal payments and proceeds of new loans, whereas the income statement
shows only interest payments.

3) Cash Flow Budgeting: A cash flow budget is a summary of the cash inflows
and outflows for a business over a given time period. As a forward planning tool,
its primary purpose is to estimate future borrowing needs and the loan repayment
capacity of the business. Cash flow budgeting is to assess the whole farm plan.
Table 18.3 Simplified Cash-Flow Budget
(Amount in Rs)
Particulars Time Period I Time Period II
1. Beginning cash balance 1000 1000
Cash inflow
2. Farm products sales 2000 12000
3. Capital sales 0 4500
4. Miscellaneous cash income 0 500
5. Total cash inflow 3000 18000
Cash outflow
6. Farm operating expenses 3500 1800
7. Capital purchases 10000 0
8. Miscellaneous expenses 500 200
9. Total cash outflow 14000 2000
10. Cash balance (5 – 9) - 11000 16000
11. Borrowed funds needed 12000 0
12. Loan repayment (principal and 0 12720
interest)
13. Ending cash balance (10 + 11 – 12) 1000 3280
14. Debt outstanding 12000 0

Here, two time periods are considered. In the time period I, there is Rs.3,000
cash inflow and Rs.14,000 cash outflow, leaving a projected cash balance of -
Rs.11,000. This would require a borrowing of Rs.12,000 to permit Rs.1000
minimum ending cash balance. The total cash outflow in the period II is
Rs.18,000 which leaves a projected cash balance of Rs.16,000 and it permits
paying off the debt incurred in period I, estimated at Rs.12,720 when interest is
included. The final result is an estimated Rs.3,280 cash balance at the end of

219
second period. The primary use of a cash flow budget is to project the timing and
amount of new borrowing; the business will need during the year and the timing
and amount of loan repayments.

d) Complete or Whole Farm Budgeting: It is a technique for assembling and

organizing the information about the whole farm in order to facilitate decisions
Table 18.4 Complete Budget Showing Projected Income,
Expenses and Profit.
Particulars Amount (Rs)
I Income: i) Cotton 54,000
ii) Paddy 43,000
iii) Sorghum 13,500
iv) Dairy products 40,000
Total income 150,500
II Variable Expenses: i) Fertilizers 11,900
ii) Seeds 3,600
iii) Plant protection chemicals 7,900
iv) Fuel and oil 4,050
v) Machine repairs 2,650
vi) Feed purchase 1,600
vii) Veterinary expenses and other expenses 30,100
viii) Custom hire charges 10,250
ix) Miscellaneous expenses 2,450
Total variable Expenses 74,500
III Fixed Expenses: i) Tax 2,600
ii) Insurance 1,250
iii) Interest on debt 22,000
iv) Machinery depreciation 7,200
v) Building depreciation 3,200
Total fixed expenses 36,250
Total expenses 110,750
Net Farm Income (Rs. 150,750 – 110,750 ) 39,750

about the management of farm resources. It attempts to estimate all items of

costs and returns and it presents a complete picture of farm business. It is
generally used by beginners or by those farmers who want to completely
overhaul their existing farm organization and operation. Complete and partial
budgeting are mutually complementary, i.e., the partial budgeting should be used
at various stages of complete budgeting in order to decide the changes to be
effected in the farm organization. The process of complete budgeting involves: i)
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appraisal of existing farm resources, their uses and efficiency, ii) appraisal of
alternatives or opportunities or various production activities that can be included
and their resource requirements and iii) preparing and evaluating the alternative
plans for their feasibility and profitability. The above table shows an estimated
profit or net farm income of Rs.39,750, if the prices and yield are actually
realized. Changes in any of these factors will obviously affect the actual profit
received from operating the farm under this plan.

1) Uses: i) It provides a basis for comparing alternative plans for profitability.

This can be particularly useful when planning is carried out for growth and
expansion.

ii) A detailed whole farm budget showing the estimated profit can be used to
borrow the necessary operating capital.

2) Complete Budgeting and Partial Budgeting: The difference between these

two are: i) Complete budgeting accounts for drastic changes in the organization
and operation of the farm, while partial budgeting treats minor changes only. ii)
All the available alternatives are considered in complete budgeting, whereas
partial budget considers two or a few alternatives only. iii) Complete budgeting
is used for estimating the results of entire organization and operation of a farm,
while partial budget helps only to study the net effects in terms of costs and
returns of relatively minor changes.

e) Linear Programming: George Dantzing (1947) developed the simplex

method for optimal transport of ammunition quickly with minimum cost. Linear
programming is a mathematical method of analysis, which finds the “best” or
optimal combination of business activities to meet a certain objective. Three
components are needed to solve a problem with linear programming technique.
They are: 1) a desire to maximize or minimize some objective, 2) a set of
activities or processes available to accomplish this objective and 3) a set of
constraints or restrictions that limit one’s ability to achieve this objective.

1) Basic assumptions of Linear Programming

i) Proportionality or linearity: Linear relationship exists between activity and
resource. For example, if one acre requires 30 man days, 100 Kgs of nitrogen
and Rs.60 of other variable expenses to produce 20 quintals of maize output,
then 10 acres of maize would require exactly 10 times of each resource to
produce 200 quintals of output.

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ii) Additivity: The total amount of resources used by several enterprises on the
farm must be equal to the sum of resources used by each individual enterprise.
Hence no interaction is possible. The same is true for the products also.

iii) Divisibility: Fractions can be used and enterprises can be produced in

fractional units. Resources and products are infinitely divisible.

iv) Non-negativity: None of the activity is negative.

v) Finiteness: Number of activities and constraints are finite.

vi) Certainty: Almost all planning techniques assume that resources, supplies,
input - output coefficients and prices are known with certainty.

2) Concepts used in Linear Programming

i) Solution: A solution refers to any set of activities Xj, j = 1, 2, 3, ..., n, which
satisfies a system of inequality constraints. There may be innumerable solutions
to a given linear programming problem.

ii) Feasible Solution: Any solution to a linear programming problem is said to

be feasible, if none of the Xj is negative.

iii) Infeasible Solution: It refers to a solution, where some of the variables, Xjs,
appear at a negative level.

iv) Optimum Solution: One of the feasible solutions is optimum, provided a

feasible solution exists. Such a feasible solution, which optimizes the objective
function, is called an optimum solution. The set of Xj in this case satisfies the
set of constraints and non-negativity restrictions and also maximizes the
objective function.

v) Unbounded Solution: Many a time, faulty formulation of a linear

programming problem may result in an arbitrarily large value of the objective
function and the problem has no finite maximum value of profit. It represents a
case of unbounded solution to a linear programming problem.

3) Estimation of Optimum Solution using Linear Programming: The

estimation of optimal solution using linear programming is given in table 18.5.

Table 18.5 (a) Estimation of Optimum Solution using Linear Programming

Particulars Per Acre of Paddy Per Acre of Ground-Nut

Income and Expenses
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 1. Gross income 2600 2000
2. Total cost 1100 600
3. Net income 1500 1400
Resource Requirements
1. Acres of crop- land 1 1
2. Hours of labour during 45 60
harvesting
3. Rupees of operating 1100 600
capital
Table 18.5 (b) Estimation of Optimum Solution using Linear Programming
Particulars Amount Paddy Ground-nut
Available Per Maximum Per Maximum
Acre Area (Acres) Acre Area (Acres)
Needs Required Needs Required
1. Maximum land. 4 acres 1 4.00 1 4.00
2. Maximum 225 hours 45 5.00 60 3.75
hours.
3.Maximum Rs. 3500 1100 3.18 600 5.83
operating capital.

Maximum Land ConstraintThere is also one additional restriction

Maximum Capital
the farmer wants to incorporate into the
Constraint
S analysis. He wants a farm plan that has
Iso Revenue Line
at least 0.7 acres of paddy. The line
Maximum Labour
B that connects points A, B, C, D and E
Ground Nut

Constraint
C in the figure 18.1 defines an area which
Feasibility

contains all numerous combinations of

D
Region

paddy and groundnut that can be

Minimum Paddy
Area Constraint produced on this farm. This region is
called the feasible region of
O A E T Paddy production. At any point outside this
Fig.18.1 Estimation of Optimum Solution
using Linear Programming Technique line, the farmer could not produce that

combination of paddy or groundnut without isolating any one of the constraints.

In order to complete the graphic analysis, it is necessary to find out the optimal
combination of paddy and groundnut that maximizes the net return to the fixed
resources of land, labour and operating capital and minimum acreage
requirements. This is done by defining a line that will give a constant amount of
net revenue, given different acreage combinations of paddy and groundnut. The
slope of the iso revenue line is calculated by the following equation:

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 Net Revenue for Paddy 1500
Slope of Isorevenue Line = = = 1.071
Net Revenue for Ground Nut 1400
Since the iso revenue line indicates a set of net revenues, it is the farmer’s
desire to find an iso revenue line as far away from the origin as possible. The
farther away the iso revenue line, the greater the net income. In addition, he
needs to be concerned that the iso revenue line is within the feasible region of
production. The iso revenue line S and T fulfils both of these requirements.
Thus, the production levels indicated at corner point D achieves the maximum
level of net Income.
Table 18.6 Optimum Solution Using Graphical Method of Linear
Programming
Particulars Non Optimal Plans Optimal Plan
A B C E (D)
1. Acres of Paddy 0.70 0.70 1.00 3.18 2.20
2. Acres of ground nut 0.00 3.23 3.00 0.00 1.80
3. Total net income (Rs) 1050 5565 5700 4770 5820
4. Total crop land used 0.70 3.93 4.00 3.18 4.00
5. Total harvesting labour used 31.5 225 225 143 207
6. Total operating capital used 770 2705 2900 3500 3500

The optimal plan is growing of 2.20 acres of paddy and 1.80 acres of
groundnut. It has a total net income of Rs.5620. This plan utilizes all the 4 acres
of crop land and Rs.3500 of capital. However, not all labour is used in this plan,
with 18 hours being unused (225 - 207). The non-optimal plans like A, B, C and
E have lesser net income than that of optimal plan (D).

4) Limitations of Linear Programming

i) Computational difficulties are enormous (unbounded solution may occur)

ii) It does not take into account the time.

i) Several real world situations are non-linear and in Linear Programming, only
linear equations are solved.

iv) Application of Linear Programming to the macro model is very difficult.

vi) Rounding up of the solutions of variable will alter the value of optimal
solution.

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C. MANAGEMENT OF IMPORTANT FARM RESOURCES

The farm problems can be classified according to the major factors of

production - land, labour, machinery, equipments and buildings.

i) Land Management

Land is a permanent resource, which does not depreciate or wear out

provided soil fertility is maintained and appropriate conservation measures are
used. It includes soil management, farm layout, and crop rotation and
management.

a) Soil fertility can be replenished by:

1) Proper cultivation and fallowing.

2) Addition of manures and fertilizers.

3) Growing leguminous crops.

4) Eradication of weeds.

5) Leveling and bunding.

6) Drainage in water - logged soils.

7) Land reclamation in saline and alkali soils.

b) Efficient Lay-out
Layout of a farm refers to the manner in which a farm is divided into fields
and the location and arrangement of other fixtures such as irrigation and
drainage system, buildings and sheds, roads and fencing. Layout of a farm
directly affects the costs and efficiency in the use of farm resources. An efficient
layout is the one which takes into consideration the topography of the land, fits
in well with the enterprises and crop rotations, leads to the saving of labour and
ensures efficient checks and controls on farming operations.
c) Crop rotation plays a major role in depletion and improvement of soil fertility.
Inclusion of leguminous crop improves soil fertility. Cropping system refers to
the sequences of crops grown to maintain the fertility of soil.

ii) Farm Labour Management

Labour efficiency in agriculture refers to the amount of productive work
accomplished per man on the farm per unit of time. Inefficient labour also
results in low production, which in turn means low wages for the labour.

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 On Indian farms, land is limited and labour is abundant. The resource
availability on the farms is, thus, imbalanced leading to a low production and in
turn results in low farm family labour earnings.

Small + Limited + Over Crowding + Poor

Holding Capital of Farm Labour Management

Imbalances in Resource Availability and Utilization

Low Production

Low Resource-Use Low Farm Family

Efficiency Labour Earning

Low Capital Formation Low Savings

a) Classification of Farm Labour: In India, farm labour can be classified into:

1. Farm manager labour: Indian farmer is a manager, capitalist and a

labourer.
2. Family labour
3. Permanent hired labour.
4. Casual labour.

b) Improving the Efficiency of Farm Labour: In order to increase the overall

production and also to improve the resource use efficiencies of other resources,
the efficiency of farm labour has to be improved. Labour efficiency can be
improved by:

1) Enlarging the size of farm business - expansion of land area, adding more
labour intensive enterprises.

2) Planning labour distribution -enterprise combination (mixed farming).

3) Improving farm lay-out (defective lay-out results in wastage of labour in

operations like ploughing, planting, etc.

4) Improving labour management with incentive and training of the workers.

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5) Simplification of farm work (Its objective is a more efficient use of labour
and other resources by improving work methods so that more and higher quality
of work is accomplished in less time with less energy).

iii) Management of Farm Machinery

Due to seasonal nature of agricultural operations, the farmers are facing

difficulty in timely and successful performance of agricultural operations,
especially during the peak labour use periods; at the time of sowing, harvesting
and threshing. In order to smoothen these peaks, labour saving devices can be
introduced by mechanizing some selected agricultural operations. Then, the
farmer has to decide how much capital he should invest in machinery and which
machines he should buy, whether to hire rather than buy a machine.

a) What cost to take into account?

Only additional costs involved should be considered when making decisions

on machinery investment. For example, for implements drawn by bullocks, feed
costs can be ignored because bullocks have to be fed any way. Only where the
bullocks are fed more, because the new implement demands that, feed costs can
be added. Partial budgeting technique is used to calculate the economics of
buying a machine in this case.

b) Rate at which costs are to be charged?

Since the farmer purchases future services when he buys a machine, he

should consider expected future costs of fuel, oil, taxes, interest, etc rather than
past or present costs. If a farmer borrows money to buy a machine the actual
interest rate paid is the appropriate charge to make. The opportunity cost of
capital should be considered to assess the interest charges on the machine, if the
farmer has severe financial constraints.

c) Selection of size of machine to buy: The key points to be considered while

deciding upon the size of a machine are as follows: 1) The difference in the
initial cost of the large and small machines, 2) The annual use to be made of the
machine and 3) The amount of additional labour saved by the large machine.

d) Break Even Analysis: Break-even point is the minimum size of operation

required to meet the total costs. At this point, the total cost and total revenue
break even, i.e., the profit is equal to zero. For deriving the break even point:

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 Cost / Revenue
F TR
Q=
P-V
TC
Where Q = quantity of output. B
P
F = Annual fixed cost. FC

P = Custom charges per unit of output.

0 Q Output
V = Variable cost per unit of output. Fig.18.2 Break-Even Output

If F=Rs.3,500, P=Rs.8 for threshing one quintal of paddy and V=Rs.3, then
the break even point for a paddy thresher is given by : Q= 3,500/[8.00-3.00]=
700 quintals. In order to cover the total costs, the thresher has to thresh 700
quintals of paddy per year. Unlike in the break-even analysis for direct
production investments, in this case, P is taken as custom charges (instead of
price); because if the farmer does not buy this machinery, he should have to hire
the machinery for which some rate is charged. So the custom charge is taken as
the price of the particular operation per unit time. Break-even point is
graphically represented in the figure 18.2. Here, OQ is the break-even output
level.

iv) Management of Farm Buildings

The main purpose of farm buildings is to store farm equipments, to maintain

and preserve stored products, provide shelter to the livestock and ensure
efficiency of operations. Building has to be constructed only, if there is an
urgent need for it. Buildings have to necessarily increase the efficiency of other
farm operations and thereby the farm income. Economy in construction and
management and sanitary and comfortable conditions are essential requirements
of a building. Some important steps to be followed in attaining these objectives
are: a) determination of the functional requirements of the structure; b)
designing of the structure for flexibility to meet changing demands; and c)
designing for the least economical method of construction which should meet the
standards for particular structure. For every farm situation, one has to decide:

1) What should be the type of building?

2) Whether to construct a new building or to remodel the old one?

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 3) What should be the optimum size and design of the building?

4) To what extent the farm building should be flexible in design?

After deciding the above points, careful decisions have to be made on

location, orientation with respect to sun and wind, sequence of operations,
hygienic conditions etc.

a) Buildings as an Input

Buildings like machinery, livestock, labour and land are a resource essential
to the farm production. As it is used along with the other resources, marginal
investments made on farm buildings must bring the highest returns to the farmer.
Farm buildings increase income of the farm through saving labour, increasing the
quantity of production and improving the quality and time value of crop and
livestock products. Buildings, therefore, must be provided, where the operations
can be carried on efficiently.

Chapter 18: Questions for review.

1. Fill up the blanks.

i) At break even level of output, and are equal.

ii) At break even point, profit = .

2. Define the following:

i) Farm planning.

ii) Farm budgeting.

iii) Objective function.

iv) Feasible solution and Optimal solution.

v) Infeasible solution and Unbounded solution.

vi) Non-negativity constraint.

3. Write short notes on the following:

i) Objectives of farm planning.

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ii) Characteristics of a good farm plan.

iii) Components of farm planning.

iv) Partial budgeting.

v) Enterprise budgeting.

vi) Cash flow budgeting.

vii) Complete budgeting.

viii) Farm lay-out.

ix) Management of machineries.

x) Management of farm buildings.

xi) Break even output.

xii) Land management.

4. Answer the following:

i) Explain the different steps involved in planning.

ii) What do you mean by ‘Linear Programming’? Explain the assumptions,

uses and limitations of linear programming technique.

iii) How planning differs from budgeting?

iv) Distinguish between partial budgeting and complete budgeting.

v) How soil fertility can be improved?

vi) List out different categories of farm labour. How the efficiency of farm
labourers could be increased?

***

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