Comparative Cost Return Analysis

of Different Farm Enterprises

Ismat Jerin Nishu

Lecturer
Haor and Char Development Institute
Bangladesh Agricultural University
Mymensingh-2202
 Cost of Production

What are costs?

• The economy is made up of thousands of firms that produce the goods and services,
that we enjoy every day: General Motors produces automobiles, General Electric
produces lightbulbs, fan and General Mills produces breakfast cereals.
• Some firms, such as these three, are large; they employ thousands of workers, and
have thousands of stockholders who share in the firms’ profits. Other firms, such as
the local fish farm or a store, are small; they employ only a few workers and are
owned by a single person or family.
When an entrepreneur undertakes production of a commodity, he must pay prices for
the factors which he employs for production. He thus pays wages to the labourers
employed, prices for the raw materials, fuel and power used, rent for the building he
hires for the production work, and the rate of interest on the money borrowed for
doing business. All these are included in his cost of production
• Costs are expenses incurred in production
• The firm will earn economic profits only if it is making revenue more than the
total costs. The economic goal of the firm is to maximize economic profits.
• Economic Profit: Total revenue minus total cost, including both explicit and
implicit costs
• Accounting profit: Total revenue minus total explicit cost.
• Explicit costs are defined as costs that involve spending money. For example,
Rent for building, cost of ingredients, cost of workers.
• Implicit costs are defined as costs that don't need the company to spend money.
For example, opportunity cost of capital.
• So, explicit costs are costs that require a payment, while implicit costs are costs
that do not require a payment. Both are important to consider when making
business decision.
• Opportunity Cost is the cost of the next best alternative forgiven.
• For instance, you used Tk. 300,000 of your savings to buy a fish farm
from the previous owner. If you had instead left this money deposited
in a savings account that pays an interest rate of 5 percent, you would
have earned Tk.15,000 per year. To own the fish farm, therefore, you
have given up Tk.15,000 a year in interest income. This forgone Tk.
15,000 is one of the implicit opportunity costs of your business.
• Economists include all opportunity costs when analysing a firm,
whereas accountants measure only explicit costs. Therefore, economic
profit is smaller than accounting profit.
 Short Run and Long run
• Short Run
Short run is a period of time in which output can be changed by changing only the
amount of variable factors
A time period when at least one input, such as plant size, cannot be changed
Plant size is the physical size of the factories that a firm owns and operates to
produce its output
There are some inputs or factors which can be readily adjusted with the changes in
the output level
The factors such as raw materials, labour, etc., which can be readily varied in the
short run with the change in the output level are known as variable factors and
Thus, the short run is a time period in which only the quantities of variable factors
can be varied, while the quantities of the fixed factors remain unaltered.
• Long Run
On the other hand, the long run is defined as a period of time in which the quantities of
all factors may be varied.
The factors such as capital equipment, building which cannot be readily varied and
require comparatively a long time to make adjustment in them are called fixed factors
It takes time to expand a factory building or to build a new factory building with a large
area or capacity. Similarly, it also takes time to order and install new machinery.
In the long run, the output can be increased not only by using more quantities of labour
and raw materials but also by expanding the size of the existing plant or by building a
new plant with a larger productive capacity.
 Short-Run Costs to the Firm
• Total Costs (TC)
⁃ The total costs is the sum of total fixed costs and total variable costs

• Total Fixed Costs (TFC)

⁃ Costs that do not vary with the rate of production
⁃ Thus, the fixed costs are those which are incurred in hiring the fixed factors of production
whose amount cannot be altered in the short run.
• The Variable Costs (TVC)
⁃ Costs that vary with the rate of production
⁃ Thus, The variable costs, on the other hand, are those costs which are incurred on the
employment of variable factors of production whose amount can be altered in the short run.
⁃ The total cost increases as the level of output rises
The concepts of total cost, total variable cost and total fixed cost in the short run can be
easily understood with the help of following Table and cost curves

Table 1
Total Cost, Total Fixed Cost and Total Variable Cost

Fig. 1. Total Fixed Cost, Total Variable Cost and Total Cost
 Types of average costs
• Average Fixed Cost (AFC)
⁃ Average fixed cost is the total fixed cost divided by the number of units of output
produced. Therefore,

Where Q represents the number of units of output produced

• Average Variable Cost (AVC)
⁃ Average variable cost is the total variable cost divided by the number of units of output
produced. Therefore,

Where Q represents the number of units of output produced

• Average Total Cost (ATC)
⁃ The average total cost or what is simply called average cost is the total cost divided by the number
of units of output produced. Average total cost is also known as unit cost, since it is cost per unit of
output produced.

Or
Marginal Cost (MC)
⁃ Marginal cost is addition to the total cost caused by producing one more unit of output. Or the
increase in total cost that arises from an extra unit of production.

Where Δ𝑇𝐶 represents a change in total cost and Δ𝑄 represents a unit change in output or total
product
 Cost of Production: An Example
Table 2
Average Fixed Cost, Average Variable Cost and Average Total Cost
Table 3
Computation of Marginal Cost (MC)
Short Run Total, Average and Marginal Cost Curves;

Fig. 2. Total Fixed Cost, Total Variable Cost and Total Cost Fig. 3. Average Cost and Marginal Cost
• A total-cost curve shows the relationship between the quantity of
output produced and total cost of production. Here the quantity of
output produced (on the horizontal axis) and the total cost (on the
vertical axis). The total-cost curve gets steeper as the quantity of
output increases.

• And these average cost curves show three features that are considered
common:
(i) Marginal cost rises with the quantity of output.
(ii) The average-total-cost curve is U-shaped.
(iii) The marginal-cost curve crosses the average total cost curve at the
minimum of average total cost
 Why Average Total Cost usually U-Shaped
• Average total cost is the sum of average fixed cost and average
variable cost. 180

• Average fixed cost always declines as output rises because the 160

fixed cost is getting spread over a larger number of units. 140

• Average variable cost typically rises as output increases 120

because of diminishing marginal product.

Costs
100
• Average total cost reflects the shapes of both average fixed cost ATC
and average variable cost 80

• As the number of units of output produced rises: 60

40
Initially falling average fixed cost (AFC) pulls average total cost
(ATC) down. 20

Eventually, rising average variable cost (AVC) pulls average total 0

0 1 2 3 4 5 6 7 8
cost (ATC) up. Output
• Efficient scale:
The quantity that minimizes average total cost (AVC).
It follows from above that the behaviour of the average total cost curve will depend
upon the behaviour of the average variable cost curve and average fixed cost curve.
In the beginning, both AVC and AFC curves fall, the ATC curve therefore falls
sharply in the beginning. When AVC curve begins rising, AFC curve is falling
steeply, the ATC curve continues to fall. This is because during this stage the fall in
AFC curve weighs more than the rise in the AVC curve. But as output increases
further, there is a sharp rise in AVC which more than offsets the fall in AFC curve.
Therefore, the ATC curve rises after a point. Thus, the average total cost curve
(ATC) like AVC first falls, reaches its minimum value and then rises. The average
total cost curve (ATC) is therefore almost of a “U” shape.
 Relationship between Average Cost and Marginal Cost
• Whenever marginal cost is less than average total cost,
average total cost is falling.
• Whenever marginal cost is greater than average total cost,
average total cost is rising.
• The Marginal cost curve crosses the Average cost curve’s
minimum point.
• At low levels of output, marginal cost is below average total
cost, so average total cost is falling. But after the two curves
cross, marginal cost rises above average total cost. For the
reason average total cost must start to rise at this level of
output. Hence, this point of intersection is the minimum of
average total cost Fig. 4. Relationship between AC and MC
For example, Suppose that a cricket player’s batting average is 50. If in his next innings he
score less than 50 like 45, then his average score will fall because his marginal (additional)
score is less than this average score. If instead of 45, he scores more than 50, say 55, in his
next innings, then his average score will increase because now the marginal score in greater
than his previous average score. If he scores 50 in his next innings, then his average score
will remain the same because now the marginal score is just equal to the average score.
 What is gross margin?
• Gross margin is one of the most important and simplest measures of a business’s
efficiency
• It is the result of subtracting the cost of goods sold from net sales or total revenue
• It may also be expressed as a percentage, which is often used when comparing
businesses of different sizes and different industries
• It is the percentage of a company's revenue that it retains after direct expenses,
such as labour and materials, have been subtracted
• It measures a company's gross profit compared to its revenues as a percentage
• A higher gross margin means a company retains more capital
• A higher gross margin indicates more efficient production or better pricing
strategies
 What is total revenue and cost of good sold
To determine gross margins, companies must know how to calculate net sales or total
revenue and cost of goods sold (COGS).
Total revenue (TR): The whole income received by the seller from selling a given
amount of the product is called total revenue (gross return) or, the total amount of
money generated from sales for the period.
For example, if a seller sells 15 units of a product at price Rs. 10 per unit and obtains
Rs. 150 from this sale, then his total revenue is Rs. 150. Thus, total revenue can be
obtained from multiplying the quantity of output sold by the market price of the
product.

Thus,

Where,
TR = Total revenue
P = Market price of the product
Q = Quantity of output sold
 Cost of good sold or Variable expenses

Cost of Good sold (COGS): The direct costs associated with producing goods. Includes
both direct labour costs, any costs of materials used in producing or manufacturing a
company’s products, fuel and power used, the expenses incurred on transporting and the like.
• It can also be called variable expanses or variable cost because those costs are incurred on
the employment of variable factors of production whose can be varied with the rate of
production.
• Thus, the total variable costs change with the changes in output in the short run. That
means they increase or decrease when the output rises or falls.
• Variable costs are made only when some amount of output is produced, and the total
variable costs increase with the increase in the level of production.
 Formula and Calculation of Gross Margin
Formula of gross margin
Gross margin may appear as a dollar value or as a percentage, which means you can express gross
margin with the following formulas:
The dollar formula:

The percentage formula:

For example, if a seller sells 15 units of a product at price Rs. 10 per unit and obtains Rs. 150 from
this sale, then his total revenue is Rs. 150. And the direct costs Rs.100 is associated with producing
this goods.
So, (Dollar formula)
(Percentage value)
= 33.3 %
 Net farm income
• The net farm income model was used to calculate the profitability of the
farmers
• It was calculated by deducting total cost of production from total revenue
• Net farm income (NFI) reflects income after expenses from production in
the current year and is calculated by subtracting farm expenses from gross
farm income.
• Formula of net farm income

Where,
TR = Total revenue
TC = Total cost
• Net farm income is the total profit earned by a farm operation after deducting all costs
associated with production and operation, including variable costs, fixed costs,
depreciation, and taxes. It represents the financial profitability of the farm during a
specific period.

Formula:
Net Farm Income=Gross Farm Income−(Operating Expenses+Depreciation+Taxes)
Where,
Gross Farm Income: Total income from all farm activities, including crop and livestock
sales, government payments, and other farm-related revenues.
Operating Expenses: Costs directly related to farm operations, such as seeds, fertilizers,
fuel, labor, repairs, and utilities.
Depreciation: The reduction in value of farm assets (e.g., machinery, equipment, and
buildings) over time.
Taxes: Property taxes and income taxes on farm profits.
Key Points
• Measures Profitability: Indicates the farm's financial health and sustainability.
• Reflects Efficiency: A higher net farm income shows efficient use of resources.
• Critical for Planning: Helps farmers make informed decisions about investments,
expansion, or cost-cutting.
Factors Affecting Net Farm Income:
• Commodity Prices
• Input Costs
• Market Demand
• Climate Change
• Government Policies: Subsidies, tariffs, or tax incentives.
• Farm Management Practices
 Farm Planning and Budgeting
Farm planning

What is farm planning?

 Planning means any scheme of action prepared in advance
 A farm plan is a scheme for the operation and organization of
the farm business
Farm planning is a technique for the optimum choice and
combination of farm enterprises for the most efficient use of
available resources for maximum income.
 Important uses of farm planning
i. For carrying out farmers daily operations and long-term programmes for
achieving their aims.
ii. For the use of their land, labour and other resources for the choice and
combination of enterprises.
iii. For analysing the probable effects on cost and returns of the combination of
enterprises or resource use.
iv. To provide information for formulating agricultural development programmes.
v. To improve the operations and organization of farms.
vi. To act as a fundamental tool for technical and economic development.
vii. To help farmers to improve their income and livelihood.
 Steps in farm planning
In developing an optimum farm plan, the following steps are generally
followed:
1. Specification of the technical coefficient of production
2. Specification of appropriate prices
3. Preparation of enterprise profitability chart
4. Preparation of the farm map
5. Inventory of limited resources
6. Examine the existing farm plan
7. Locate weakness of the present plan
8. List out risk to agricultural production on that farm
9. Prepare the alternative plan
10. Analysis the alternative plans
11. Selecting a plan for implementation
 Farm Budgeting

What is farm budgeting?

• Budgeting is the most widely used method of farm planning
• It is used in evaluating the farm plan in financial terms
• Budgeting is defined as the detailed quantitative statement of farm plan
or a change in farm plan and the forecast of its financial result
• It is the technique of estimating future income and expenditure
 Classification of farm budgeting
There are two types of farm budgeting
1. Partial budgeting
2. Complete budgeting
Partial budgeting:
• Partial budgeting is used when only a partial change in the existing plan is being
considered
• Partial budgeting in the context of farming involves assessing and analysing specific
changes or adjustments within the farm's financial plan.
• This method allows farmers to focus on particular aspects of their operations, such as
introducing a new crop, adopting a different cultivation technique, or investing in new
equipment. By isolating these changes, farmers can closely examine the associated costs
and benefits without having to reassess the entire farm budget.
There are three main types of changes
i. Product substitution:
Product substitution occurs when one enterprise replaces another, and it
involves the introduction, expansion, reduction, discarding, or
modification of a long-used enterprise.
Example: Boro rice enterprise instead of maize enterprise
ii. Changes of enterprises without substitution:
This category is suitable for non-land using enterprises, such as opting
for layer enterprises instead of broiler enterprises.
iii. Factor substitution:
Change in production technique. For example, using tractor or power-
tiller instead of animal ploughing
There are four question are raised in a partial budgeting
Among them, two of which are related to the financial losses (debit side) and the financial
gains (credit side).
a) Debits:
What loss of present revenue occurs ?
What extra new cost are incurred?
b) Credits:
What extra (new) revenue is obtained?
What (present) costs are no longer incurred?
c) Profit or losses:
if, credit> debit: profit
credit< debit: losses
d) Decision:
Based on net benefit
Complete budgeting:

• Complete budgeting is used when a major change in an existing farm is being

considered that will affect the cost and receipt items
• Complete budgeting relates to the entire farm plan
• Complete budgeting of a farm involves a comprehensive assessment and planning
of all financial aspects associated with agricultural operations.
 Steps of complete budgeting
i. Listing available resources and stating objectives
ii. Estimation crop acreage and livestock numbers for example, farm size,
herd size, flock size
iii. Estimating physical inputs and outputs: Fixed inputs, variable inputs and
physical production
iv. Estimating factors and product prices: Prise, quantity, cost, returns
v. Estimating fixed costs: there are four types of important fixed costs
a. Rent on land
b. Wages for permanent labour
c. Interest on operating capital
d. Depreciation cost for tools and equipment
vi. Totals and layout:
Totaling the costs and returns, Profit or loss
Break-even budget
• Neither profit nor loss, that means gains and losses are equal
• A break-even budget refers to a financial plan in which the total revenues
generated are equal to the total expenses incurred, resulting in neither a profit nor
a loss. In other words, it's the point at which the income equals the expenses, and
there's no net gain or loss.
• For businesses, creating a break-even budget involves identifying all fixed costs
and variable costs. Then, the business determines the level of sales or revenue
needed to cover these costs and break even.
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returns of integrated fish-based farming systems in Kaduna Metrolis Nigeria. Asian Research
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