Chapter 9

Factor-Factor Relationships
In the previous chapter our concern was about the use of single resource and a
single product, where the production function is of the nature Y = f (X1/X2 X3 X4
Xn ), where X1 resource is variable and all other resources are held constant. But the
producers use more than one resources in the production of a product. For example, in the
production of rice crop the farmers use seed, different types and brands of fertilizers,
pesticides, machine, human labour both hired and owned, etc. In any production
process, the producer should choose various combination of all the factors of production
within the limitations of his investment capacity. The economic level of output from a
combination of fixed factors depends on the manner in which the variable resources are
combined. Therefore, the important aspect of the study of factor factor relationship is to
find out the possibilities of substituting or combining two or more resources in the
production of a given output level, which is economic. We study the factor factor
relationship with different combinations of two resources, keeping the output level
constant at a particular level. We start the study with two resource combinations, for
simplicity of understanding to the reader,
The production function can be expressed in this case as Y = (X1 X 2 / X 3 X 4
.Xn) or Y = f X1 X 2 , i.e. X1 and X 2 are variable resources and other resources are
held constant to produce a given level of output. The objectives of studying factor-factor
relationship and substituting one resource for the other is two-fold.
1)

Minimization of cost to a given level of output of a product.

2)

Optimization of output to the fixed producing unit through alternative

resources use combinations.

Optimization of output or profit maximization actually involves the cost minimization in

the use of variable resource. There will be large number of resource combination will
give the maximum output with least cost. The question here is of finding out optimum or
least cost combination of two or more resources in producing a given amount of output.

Isoclines, Ridge lines and Expansion path

A line or curve connecting the least cost combination of inputs for all output
levels is known as isocline.(fig.14)
Ridge lines
Ridge lines are the border lines which separate complementarity from
substitution. They are called special types of isocline, joining points of equal slopes via
iso-product curves.
Expansion path
Each level of output or iso-product curve will have its own particular least-cost
combination of factors.
If all the least-cost combination points are joints to each other, the result is an
expansion line.
Fig.14 Isoclines, Ridge lines and Expansion path

X1

Border line

Expansion Path
Ridge line

INPUT

IQ3
Border line

IQ2
BL3
BL2

IQ1
BL
1

INPUT

X2

Table 12. Marginal rate of technical substitution

Input
combination

X1

X1

X2

2
3

4:1=4

3:1=3

5
1

Output
(qti)
40
40
40
40

2:1=2

3
1

MRTS =

X 2
X1

8
1

MRTS

12
1

X 2

40
1

1:1=1

40

X 2
No. of unitsof replaced resource
= No. of unitsof added resource
X1

(Substitution Ratio)

X 2
X 1
X 2
The MRS of X1 for X 2 is denoted as
X 1

The MRS of X 2 for X1 is denoted as

In Table 12, we substitute X1 for X 2 , hence the MRS is

X 2
for 40 qtl of
X1

output level. In the A combination, when we increases one unit of X1 , the amount of
X 2 to be replaced changes from 3 units to 2 units and then to 1 unit. The rate of factor

substitution is negative in all rational areas of production, and hence we do not always
bother to include minus sign.
Elasticity of substitution (Es)
The elasticity of substitution is the relative change, by which factors combine in
producing a constant output on a production contour and can be defined as the percentage
change in one factor, divided by the percentage change in the other factor, i.e.

Es=

X1
x 100
X1
=
X2
x 100
X2

X1
X1
X2
X2

orEs=

X1 X 2
.
X1 X 2

X1 X 2
.
X 2 X1

The elasticity is always negative for substitute resources and indicates how fast
the slope of a product contour changes. Es can be computed either as are elasticity or
point elasticity. Are elasticity refers to substitution over an entire portion of a product
contour. Point elasticity refers to the elasticity at one particular factor combination and
therefore corresponds to the exact marginal rate of substitution.

Substitutes and Complementary Resources

Substitutes :
Factors of production substitute for each other, in so far as different combinations
can be used to product the same level of output, i.e. when output can be maintained as
resources are reshuffled; when one factor is reduced in quantity, a second factor must
always be increased. For example, (1) higher output can be obtained from more intensive
use of fertilizer and from extending the cultivated areas. In this respect, fertilizer is a
substitute for land, (2) machinery for bullock power.
Complements :
Inputs which increase the output only when combined in a fixed proportion are
known as complements. Some factors cannot be used unless other are also present. For
example, neither tractor nor bullocks can be worked without labour input. Any increase in
number of tractors should always be combined with increase in labour, i.e. drivers.
Iso-cost lines (Equal cost lines, price line or outlay line)
Iso-cost lines indicate all possible combination of two inputs, which can be
purchased at a given outlay of investment fund.
Suppose a farmer has Rs. 100 to spend on two resources X1 and X 2 , when price
of X1 is Rs. 5 and that of X 2 is Rs.10 per unit. Then he can purchase either 20 units of
X 1 or 10 units of X 2 . When these two points are connected on a diagram by a line, we

get the iso-cost line

The slope of the iso-cost line is expressed as the ratio of the price of one input to
the price of another input. Thus the slope of iso-cost line is

PX1

PX 2 and they are linear

and determined by end points. AB is an iso-cost line. Assuming that the price of a units of
X1 is PX1 and that of X 2 is PX 2 , the number of units which can be purchased with

M units of money is:

M
M
and
respectively. The slope of iso-cost line is : AO/OB, i.e
PX1
PX 2

M
PX 2

M
PX1

M
PX 2
=
M
PX1

Unit of X 2
Units of X1

PX1
M
PX1
.
=
PX 2
PX 2
M

Principle of cost minimization

Ratio resource combinations have been defined as those falling on the portion of
the iso-quant contour with negative marginal rates of substitution between factors, i.e. an
increase in one factor allows a decrease in another. Since an input-output relationship or
production function gives rise to both factor-product and factor-factor relationships, the
two questions of (i) the optimum yield or output level and (ii) the optimum combination
of variable resources for a fixed unit, must also be decided. The problem is one of how
resources should be combined for the fixed technical unit, if output is to be expanded
from zero to the most profitable level (factor-product) with variable resources combined
in a least cost manner (factor-factor) for each level of output. The selection of resource
combination within the rational range is possible only by means of a choice indicator. The
relevant choice indicator for profit maximization is the factor-price ratio.
The principle of cost minimization (least cost combination of resources) can be
defined as if two or more factors are employed in production of a single product, cost is
at a minimum when the ratio of factor prices is inversely equal to the marginal rate of
substitution of factors.

Algebraic expression cost minimization

i)

Compute the marginal rate of substitution ratio

i.e.

X 2
X1

No. of units of replaced resource

No. of units of added resouce

PX1
Cost per unit of added resource
= Cost of units ofadded resource
PX 2

ii)

Compute price ration =

iii)

Workout the least cost combination by equating:

X 2
X1

PX1
for MRS of X1 for X 2
PX 2

Cost of adding X1 is equal to the reduction in cost from X 2 .

X 2
PX1
<
PX 2
X1

=Cost can be lessened by using more of X1 and

Less of X 2

PX 2
X1
<
=Cost can be lessened by using more of X 2
PX1
X 2

and less of

X1

This can be written as: PX 2 . X 2 = PX1 . X1 .

If at any point on the iso-quant, PX 2 . X 2 is greater than PX1 . X1 , then
the cost of producing the given output could be produced by increasing the use of X1 and
decreasing X 2 , because the cost of added unit of X1 is less than the cost of the replaced
units of X 2 . On the other hand, if at any point on the iso-quant PX 2 . X 2 is less than
PX1 . X1 , the cost of producing the specified amount of output can be reduced by

using less of X1 and more of X 2 .

This equality criterion signifies that any change in the input combination from this
point would increase cost of producing the output.

Graphic method
Since the slope of iso-cost line indicated the ratio of factor prices and the slope of
iso-cost curve represents the marginal rate of substitution, the point of factor combination
at minimum cost for a given output is at the point of tangency of these iso-lines. (fig.15)

Slope of iso-quant = Slope of iso-cost line

i.e.

X 2
PX1
=
X1
PX 2

This equality the defines the condition which applies at the point of least cost
combination of inputs. The above equation can be expresses in other terms. Any
movement down the iso-product curve results from partial withdrawal of X 2 and a
compensating increase in X1 (to maintain Y constant).

Fig 15. Least cost combination of Factors

The change in the output, in absolute terms, resulting from compensating the
addition of X1 . Therefore
X 2 .

MPPX 2

X1 .

MPPX1 , i.e.

X 2
=
X1

MPPX1
.
MPPX 2

It has been shown that the point of least-cost combination (LCC) is given by:
X 2
X1

MPPX1
MPPX2

PX1
.
PX 2

PX1
PX 2

or MPPX 2 PX1 = MPPX1 . PX 2 .

MPPX1
PX1

MPPX 2
PX 2

In other words, economic combination of factors is achieved when the return from
the marginal rupee spent on one factor is equal to return from the marginal rupee spent on
the other factor.

Arithmetical calculation of least cost

One possible way to determine the least-cost combination is to compute the cost
of all possible combination and then select the one with minimum cost. Suppose there are
five combination of inputs which can produce 25 units of output. The price per unit of
X1 is Rs. 2 and of X 2 is Rs.4. The outlay of each combination can be determined as

follows .(table 13)

Out of the above combinations, 2 units of X 2 and 8 units of X1 is the least cost
combination of inputs, i.e. at the rate of Rs.24.00 to produce 25 units of output.
Table 13. Estimation of least cost by simple arithmetic
X1

X2

Cost of
X1 @ Rs. 2

Cost of
X2

Rs.4
12.0
8.0
6.5
5.0
3.0

1
2
3
4
6

24.00
16.00
13.00
10.00
12.00

4.00
8.00
12.00
16.00
20.00

Total outlay of
@ X1 & X 2 (Rs.)
to produce 25
units of output
28.00
24.00
25.00
26.00
32.00

Chapter 10
Product-Product Relationships
This chapter deals with product-product relationship involving the allocation of
given resources between competing enterprises. Here the choice is between the
competing products, wherein the farmer is faced with the problem of combination of
crops to be grown on the limited area of the farm, by using the given limited quantities of
factors of production. The problem of product-product combination is sometimes termed
as resource use; allocation of resources between competing alternatives. The cultivator
is generally faced with the question of :
1)

How much of what to produce?

2)

How should inputs be allocated among given enterprises?

3)

What combination of enterprises be produced?

Similar to factor-factor relationship, where we held the output level constant the
choose between different combination of inputs for realizing a certain level of output, in
product-product relationship we held factor use constant and choose between various
combination of products. The objectives of product-product relationship are:
1)

Profit maximization with a given resource allocation, when two or more

products are being produced.

2)

To determine the best combination of products for a given outlay of resources.

Algebraically this relationship can be written as Y1 = f Y2 ; when more than

two products are involved Y1 = f Y2 , Y3 , Y4 ,..., Yn . When resources are fixed in

quantity, the output of one of a pair of competing commodities is a function of the output
of the other commodity. The production function for each of the two products takes the
general form of Y1 = f X1, X 2 , X 3 ,..., X n and Y2 = f X1 , X 2 , X 3 ,..., X n . Since
the quantity of resources is constant, while products are variable, the function can be
written as:
Y1 = f X1, X 2 , X 3 ,..., X n , Y2 or simply Y1 = f Y2 and

Y2 = f X1, X 2 , X 3 ,..., X n , Y1 or simply Y2 = f Y1 .

The general equilibrium condition for a given level of input requires the
knowledge of two relationships:I)Production possibility curve and (ii) iso-revenue line.
(fig.16)
Fig.16 Expansion path, Iso revenue line, Ridge line &
Production possibility curve

Y1

Expansion Path
Ridge line

OUTPUT

Iso revenue line

Border line

Production possibility curve

A
Y2
OUTPUT

The production possibility curve represents all the possible combination of two
products that can be produced with given amounts of inputs.

Marginal Rate of Production Substitution

Marginal rate of product substitution (MRPs) means the rate of change in quantity
of one product as a result of an unit increase in the other product, given that the amount
of the input used remains constant.

The MRPS of Y1 for Y2 will be

Y2
Y1

Elasticity of Product Substitution

Elasticity of product substitution (Eps) measures the percentage decrease in
output of one product Y 2 associated with a given percentage increase in a second
product Y1 .

Y2
Y2
Y1
Y2
Eps =
or
.
Y1
Y1
Y2
Y1
As the Eps of Y1 for Y2 increases, the opportunity line has a greater curvature
towards the axis, of an opportunity line with a high elasticity will have a much sharper
curvature than the one with low elasticity.

Iso-revenue line
The choice indicator for a farm product-product relationship is provided by an
iso-revenue curve.The iso-revenue line indicates the ration of prices for the two
competing product. It is a line which defines all the possible combination of two
commodities, which would yield an equal revenue or income.

Determination of optimum product combination

The optimum combination of two enterprises with the given resources can be
made only if the choice criterion is known. The product price ratios provide the choice
indicator for profit maximization. Maximum profits are attained, with the costs or
resources fixed in quantity, when the marginal rate of product substitution is equal to
inverse of the product price ration. In simple algebraic terms, it can be expressed as:
Y2
Y1

PY1
PY 2

Where Y2 Y1 is the marginal rate of product substitution and PY1 is the price of
Y1 and PY 2 product.

The above criterion can also be written as: Y1

PY!

= PY 2

Y2 . This

equation states that with resources allocated to maximise profits, the marginal value
product of a unit of resource allocated to Y1 is equal to the marginal value product of a
unit of resource allocated to Y1 is equal to the marginal value product of a unit resource
allocated to Y2 .
When
When

Y2
PY1
<
Profits can be increased by substituting Y1 for Y2
Y1
PY 2
Y2
PY1
>
Profits can be increased by substituting Y2 For Y1 .
Y1
PY 2

The optimum product combination can be achieved when the slope of the isorevenue line , and the slope of the production possibility curves are equal. Or where the
iso-revenue line is tangential to the production possibility curve, the two slopes are equal
and therefore it is the point of optimum product combination.
Substitution of Y1 for Y2 is always profitable, as long as the slope of the
opportunity curve is less than the slope of the iso-revenue. Substitution of Y2 for Y1 is
always profitable when the opportunity line is greater than the slope of the iso-revenue
line. At the point of tangency, the ratio of marginal cost of two product is equal to the
ration of their marginal value products.
Tabular method
The other method is to calculate the net revenue from many combination and
locate the one which promises highest returns. (table 14)
Ex : When 700 units of X are used PY1 = Rs. 7 Q ; PY 2 = Rs. 10 Q .
Table 14. Determination op optimum product combination
Y1

Y2

Y1

Y2

Y2

0
10
20
30
40
50

78
76
72
67
60
48

10
10
10
10
10

2
4
5
7
12

2/10=0.2
=0.4
=0.5
=0.7
=1.2

Y1

PY1
Y1

0
70
140
210
280
350

PY 2 .
Y2

Total
Revenue

780
760
720
670
600
480

780
830
860
880
880
830

60

28

10

20

=2.0

420

280

700

70

10

28

=2.8

490

490

Computations of the maximum revenue combination of two products Y1 and Y2 for

700 units of X . When price of Y2 is Rs. 10/qtl and price of Y1 is Rs. 7/qtl, the
maximum revenue combination of products is 40 units of Y1 and 60 units of Y2 . The
total revenue is Rs.880 at this point.
Py1
Y2
7
7
<
=
=
=0.7 .
Py 2 10
10
Y1

Chapter 11
Risk and Uncertainty
Agriculture depends on climatic factors like rainfall, sunlight, humidity, etc., and
always not easy to predict. Knowledge on various aspects that affects the crop and how to
overcome these situations would enable the decision maker to manage the farm in an
efficient manner.
Frank knight classified the knowledge situation as follows
Knowledge situation
Perfect (it is a fallacious one and does one and does not
Reflect the real world situation)

imperfect

Risk
A prior

Uncertainty
Statistical

A situation is said to be risky, if the occurrence of future events can be predicted

by the specified level of probability. Risk represents less imperfection in knowledge that
does uncertainty. A priori risk means based on advance information about the occurrence
of an event can be predicted.

A priori risk prevails when sufficient information is available about the

occurrence of an event. Eg. tossing a coin. Contrary to this, a statistical risk can only be
predicted on the basis of occurrence of several observations in the past. Mortality tables
of insurance companies provide good examples of statistical risk. Because of the
quantification of imperfect knowledge under a risk situation, the event can be insured.
Decision. If the future is so uncertain, farmers will not commit any of his
resources to a production plan such a decision itself is a farmers reaction to the imperfect
knowledge situation.
It is very difficult to (classify) or differentiate above two situation risk and
uncertain hence in most of the literatures it is used interchangeably.
Types of risk & uncertainties: It can be classified into the following five categories.
1. Economic uncertainties:
In general, farmers face fluctuations in prices of input & output. These type of
uncertainties are reduced markedly in many countries by announcing the price prior to
the sowing season. Mostly these uncertainties are due to changes in demand and supply
and national and international policies which are beyond the approach of an individual
farmer.
2. Physical and Biological uncertainties:
Flood or drought, hailstorms, frost, pests and diseases may affect the yields
quantity and quality of output.
3. Technological uncertainties:
Technological progress may make the existing technologies obsolete and
inefficient. For example availability of new efficient machineries may result in the
reduction of the value of existing machines and non availability of spare parts.
Introduction of new varieties may create market problems.

4. Institutional uncertainties
Institutions like government, bank etc. may also cause uncertainties for an
individual farmer. Change in institutional policies on prices, import and export, input
supply, marketing, credit and subsidy may have an impact on cost and returns.
5. Personal uncertainties
Unexpected events in the family such as death, major illness may affect the
execution of the farm plans.

Safeguards against risk & uncertainty

Farmers adopt various measures to manage risk and uncertainty in farming.
1. Selection of Enterprises with low variability.
In practice, data on yield and price of various enterprises over a period of time
may be used to find the range, variability and coefficient of variation. Based on this
choose the enterprises with low variability. Eg. Rice under irrigated conditions compared
to vegetables.
2. Discounting Returns
Planning based on single value expectation of yield, income or prices may be
misleading. Hence we have to deduct a safety margin from the expected prices, yields or
income to incorporate risk.
In terms of profit maximization
Px
MPP = ----Py
Discounting means that Py is decreased by some proportion, Px is increased and
MPP would assume higher value ie. Lower production. Thus the profit maximizing level
X is lower now.
3. Insurance

It is a well accepted method to safeguard against risk and uncertainty. So far, crop
and livestock insurance cover is given to the farmers who availed crop loans. At present
Government is seriously thinking of extending this cover to all the farmers. And also, in
our country insurance cover is not given for dry land crops. Hence, it has only a very
limited role in environment around the farmers.
Advantages of insurance. 1) stabilize farm income 2) improve credit worthiness 3)
incentive to adopt new technology and 4) reduce government obligation to provide relief.

4. Forward contracts
Forward contracts are made to reduce the uncertainty in input supply, price
fluctuations etc. forward contact may either be in money or kind (eg) employment of
permanent labour on the farm for a period of one or two years based on some agreement.
Fixed rent in kind or cash is a good example of forward contract. Contracts in kind
reduce income variability where contracts in money do exactly the opposite. Sale of crops
such as banana and mango to pre harvest contractors, tie up arrangement with sugar mills
to sell sugarcane are few examples of contract sales to safe guard against price risk.
5. Flexibility
This refers to the convenience with which the organization of production on a
farm can be changed. It helps in obtaining advantages of economic & technological
changes. There are three types.
a. Time flexibility: Time flexibility may be introduced by proper selection of
products. Eg. Short lived structure is more flexible. Annual / seasonal crop is
more flexible than perennial corps.
b. Cost flexibility: When time flexibility is of limited use, cost flexibility becomes
important. Though hiring a machine is costly than owning. The farmer may hire it
in order to have cost flexibility Eg. Hiring a tractor / sprayer / polisher.
c. Product flexibility: It refers to the ease with which a farmer divert farm resources
from enterprise to other. Changing the enterprises in response to price signals. Eg.
rice to sugarcane. Resources may be diverted to the most profitable enterprise. Eg.

machines, farm structures etc. which can be switched readily from one product to
another.
6. Liquidity and Asset Management
More liquid assets are cash on hand and deposits in the bank. Slightly less liquid
assets are seeds, fertilizers. Least liquid assets are land and machineries. Here the motive
is transactional not speculative. Cash can be converted to any form within short period.
Hence, one has to keep some amount to meet contingencies in farming. In general
farmers have cash for cultivation purposes.
7.Diversification.
It is meant for stabilization of farm income. Though specialization has certain
advantages it may lead to income fluctuations due to variation in yield and prices.
Diversification is one of the methods of safeguarding against income variability by
having few or more enterprises. Example growing different crops, crop and livestock
enterprises etc. it is useful and popular method to safeguard against risk & uncertainty.
This is useful if there is variation in yields of commodities.
8. Maintaining resources in reserve
If a resource will not be available at the right time, then one can stock the
resource. It depends on the fund available with the farmers and the cost of stocking.
9. Adjustment to uncertain availability of Inputs
If the best input is not available i) use the second best and (ii) use of less quantity.
If the required quantity is not available, use the level of input at which the marginal return
is equal for all crops. This is always less than the profit maximizing level.
Risk & uncertainty in Farming
Farmers normally face the following three types of uncertainties.(1)product
price uncertainty, (2) yield variability and (3) uncertain availability of inputs.

1. Product Price Uncertainty

Since the production depends on price of a commodity uncertainty in price will
have impact on returns from an enterprise. It has to be accounted in deciding the level
and combination of enterprises. Normally farmers face the following four situations.
1. High return enterprise with low price variability
2. Low return enterprise with high price variability
3. Low return enterprise with low price variability
4. Low return enterprise with high price variability.
If we consider (1) and (4), we select (1). If the situation is (2) and (3), then the
farmer has to make a rational decision by following the rule.
Value of taking risk (P) = Cost of risk (R)
Pr
P
= ------ = -------Pp
R
P- return / profit ;R Risk;Pp is the weight attached to a unit of return
Pr is the cost involved per unit of risk
Farmers take risk based on their mental attitude and also they assign weights for risk
accordingly.In general, as return increases the risk also increases. This can be represented
by graph.
2. Yield uncertainty
It is due to changes in technologies. When a farmer is using old technology
which is inefficient compared to new technology, then he has to face variability.
There are four enterprise alternatives are available to the farmers.
1. Low yield variability and high risk enterprise
2. Low yield variability and Low risk enterprise
3. High yield variability and High risk enterprise
4. High yield variability and Low risk enterprise
Here within (1) and (4) ,obviously (4) will be chosen. For (2) and (3), rational
decision have to be made following the rule.
Y.Py > V.Pv

 Y change in yield, Py Price of output,

Pv - cost the farmer put on the yield

variability, V change in yield variability, V. Pv cost of taking risk in yield,

Y.Py- return from taking risk.
3. Uncertain availability of inputs
Some inputs availability may be uncertain for some farmers. Eg Fertilizer, Hybrid
seed. This can be tackled by
1. Adjustments in changing the level of enterprises.
2. Adjustment in the planting dates
3. Adjustment in application rates of inputs, especially on the growing crops.

Chapter 12
Management of Important Resources
Management of Resources is important since the resources are scarce and
involve cost. It includes mobilization and allocation among different alternatives.
Mobilization of Resources
Farm resources can be mobilized in the following ways: (i) Own (ii) Lease (iii)
Custom Hire of Resources and (iv) buying.
Alternative to owning land & machinery, leasing and custom hiring is in practice.
Lease
A lease is a formal agreement whereby the machine owner grants control and use
of the machine to the user for a specified period of time for an agreed amount of
payment.
Short term leasing covers days or months while long term leasing may cover one
or more years.
Leasing land:
A lease is a legal contract where by the landowner or land lord gives the tenant the
possession and use of an asset such as land for a period of time in return for a specified
payment. The payment may be cash, a share of the production, or a combination of the
two. Oral leases are legal in many countries. But it is not recommended. This may lead to
disputes if the memories fail. A lease should be written and contain the following
information: Description of the land, Land owner and tenant period, term of the lease,
rent amount, time of payment, rights and signatures.
Livestock share:
It is like crop share. Mostly share are 50:50 for owner and tenant / leaser.
Labour share:
This is in practice for crop & livestock enterprises. Actually the labourers put
their services in cultivation of land and they get their share as per the agreement made.

Labour Hiring
Human labour can be hired on daily basis or on monthly basis or for years.
Accordingly wages are paid.
Water
Water is an important resource in farming. It is supplied through canals if source
of water is reservoir/ tanks. Farmers own wells. Some farmers purchase water from
neighbours. Pricing of water is done by seller farmer.
Land Management
Land has a wider meaning in economics. Land stands for all natural resources
which yield an income. It represents those natural resources which are useful and scarce.
From economics point of view, the concern is more profitable use of these resources
through optimal utilization.
Land use efficiency measures
a. Yield per hectare
If refers to the productivity of individual crops. It is the ratio of total production to
the number of hectares. It is presented in terms of kg/ha (or)qtl/ha.
Total production
--------------------Number of hectares
b) Production efficiency
The production efficiency with respect to any particular crop enterprise can be
Yield per hectare =

expressed in terms of percentage as compared with the average yield of the locality
Particular crop yield per ha in a farm
Production efficiency of a crop in a farm= -------------------------------------------x100
Average yield of the locality
Example: Paddy yield per hectare of farm (A) = 80 quintals
Average yield of the locality
= 60 quintals
80x100
Production efficiency of farm (A) = ------------- = 133.33%
60

Higher the percentage, the higher the efficiency of that crop production in the farm. If the
value is more than 100 it indicates the efficiency of crop production in the farm.
c) Crop yield Index
It is a measure of comparison of the yields of all crops on a gives farm, with the
average yields of those crops in the locality. The relationship is expressed in percentage
terms.(table 15) This is a convenient measure, because it combines all the yields into a
single figure. If the crop yield index is more than 100, one could include that efficiency is
more.
Example
Table 15. crop yield index
Crop
(1)

Locality
(2)

Farm
(3)

Hectares of
crop on farm
(4)

Cotton
Paddy
Maize
Total

24.70
37.05
49.40

37.05
49.40
24.70

2
8
4
14

Crop Yield Index =

(%)

Total percentage
----------------------Total area

Crop yield
of farm (A)
as a % of
(5)=3/2
150
133
50

% multiplied
by hectares
(6)=(5x4)
300
1064
200
1564

1564
= --------------- = 111.71
14

d) Cropping intensity
It measures the extent of the use of land for cropping purposes during a given
year. It is expressed as percentage.
Gross cropped area
Cropping intensity = -------------------------------x100
Net cropped area
Where, Net cropped area

= Total cultivated area:

Gross cropped area

= Net cropped area + area sown more than once.

Example:

Gross cropped area

= 8 ha

Net cropped area

= 4 ha

Cropping intensity

= 8/4 x100

=200%

The cropping intensity is 200 per cent which indicates the better utilization of
land. It depends on the water available for cultivation purpose. In dry lands it is
only 100 %.

Labour Management
Labour
Any work whether manual or mental which is undertaken for a monetary
consideration is called labour.
Classification of farm labour
Farm labour is classified into: 1) Unpaid labour; (2) Paid labour (hired). Unpaid
labour is further classified into a) Farmers own labour, (b) Family labour. Paid labour is
further classified into:
1. Permanent or attached labour
2. casual hired labour or seasonal labour.
Farm Managers labour, farm familys labour and permanent hired labour are fixed
resources due to general lack of mobility.
Farm Managers labour
Indian farmer is a manager. Managers labour is of course the best type of
available labour due to his personal interest. Family labour is the main source of labour
on Indian farms.
Permanent hired labour
It is hired on cash, kind or crop share basis for a fixed period i.e. six months or
one year.
Casual labour
It is hired from time to time and according to the demand for agricultural
operations. The wages are paid on daily basis or on the basis of work done.
Skilled labour

Specilalised labour and trained labours for specific jobs is known as skilled labour
eg. tractor driver.
Unskilled labour
It is ordinary labour employed for manual work, which does not need any training
of specialized nature.
Labour efficiency
Labour efficiency in agriculture refers to the amount of productive work
accomplished per man on the farm per unit of time.
Labour efficiency measures
1) Marginal analysis in a specific situation, 2) Conventional measures and (3)
labour efficiency index.
1. Marginal productivity analysis
Marginal productivity is the output produced by an additional unit of labour input.
Average productivity of labour is the output per unit of labour.
2. Conventional measures
A) Hectares of crops per man
It indicates the number of days of productive work done by a worker on the farm
in crop production. Man equivalent is defined by converting woman labour day and child
labour day into men labour day. (i. e) 2 men labour days = 3 women labour days and 1
man labour day or manday = 2 children labour days.

a. Hectares of crops per man =

Total area in hectares

------------------------Man equivalents

b. Out turn per worker

Average output by the average number of earners

------------------------------------------------------------Average number of earners

Value of output minus cost of input factors excluding

c. Return per worker =

human labour
------------------------------------------------------------total number of workers

3. Labour efficiency index

In areas where labour efficiency standards have been set on the basis of the
amount of labour to be performed on crops and livestock, the labour efficiency can be
worked out.
Suppose the labour required for a given farm is calculated at 500 days of work on
crops and 250 days on livestock. The normal labour cost for such a combination is
Rs.25,000 but the actual labour cost is Rs.30,000.
The efficiency index is calculated as
25000
=
--------------- X 100 = 83.33
30,000
(ie) the efficiency is below normal (100)
Expressed as percentage of normal cost
30000
=
--------------- X 100 =120
25000
(ie) the cost is above normal (100) and hence the efficiency is more

Water Management
Available water has to be utilized in an efficient manner. Crops have to be chosen
based on water availability. Method of irrigation and types of channels used for irrigation
would also influence the water use efficiency.

Measures of water use efficiency

There are two types of measures viz., 1. Physical and 2) Monetary
i. Physical measures:
It is the rate of yield to water use a) Quantity of output/ha.cm of water used b)
Quantity of output/irrigation
ii. Monetary measures :
It is the ratio of gross return / profit to water used. Following are the measures. a)
Gross return/ ha cm. b). Profit / ha. cm c) Gross return / irrigation d) Profit per irrigation.

Output
Water use efficiency =--------------------------Quantity of water used
Example
In Farm A paddy yield per ha was 6000 kgs and the water used was 150 ha cm.
Water use efficiency = 6000/150 = 40 kgs / ha cm. In Farm B paddy yield per ha
was 5000 kgs and the water used was 100 ha cm.
Water use efficiency = 5000/100 = 50 kgs/ha cm. It indicates that in farm B
water use efficiency is more than in farm A.

Chapter 13
Farm Financial Management
Financial management is needed for all farms, irrespective of their scale
and nature of crops and enterprises. In fact, the success towards attaining farms goals
heavily depends upon how good is financial plan.
Financial management is concerned with the efficient use of an important
economic resources, namely capital funds.
Financial management is concerned with
Estimation of financial need.

Acquisition of funds from appropriate sources.

Allocation of funds among short term and long term assets and

Ensuring their efficient use.

Goals of financial management

To maintain liquidity to meet current activities.
To maximize profit
To maximize wealth
To maximize earning per share.
To achieve social responsibility and
To achieve efficiency.
Financial management includes
(a) Working capital management (b) capital budgeting.
Working capital management
It refers the efficient use of funds available for day to day operations of an
enterprise. It also represents the excess of current assets over current liabilities including
short term loans.
Capital budgeting
It refers to the long term planning involving proposed capital outlays and
planning.

Tools of Financial Management

Cost of capital

Financial leverage (Trading on equity)

Capital budgeting

Ratio analysis

Funds flow analysis

Financial Statements :
There are three important financial statements. They are i) Balance sheet ii) Income
statement iii)Cash flow statement or Fund flow statement.
Table 16. Balance sheet of a farmer as on 31st March 2006
Sl.
No.
I
1.
2.
3.
4.
5.
6.

Assets
Current assets
Paddy grains
Seeds and fertilizers
Cash on hand
Savings in the bank
Poultry birds
Farm yard manure
Sub Total

II
1.
2.
3.

III
1.
2.
3.

Intermediate assets
Milch animal
Share in co-operative
bank
Farm implements
Sub Total
Long term assets
Land
Building
Tractor
Sub Total
Total

Value in Rs.

S.
Liabilities
No.
I
Current liabilities
25000 1.
Wages for Farm labour
1500
to be paid
500 2.
Interest to be paid
1000 3.
Tax payable
2500 4.
Crop loan
800 5.
Instalment for term loans
Sub Total
31300
II
4200 1.
2000
800
7000

III
150000 1.
25000
125000
300000
338300

Value in
Rs.
500
500
1000
1000
4000
7000

Intermediate liabilities
Loan for animal

5000

Sub Total

5000

Long term liabilities

Long term loan

137000

Sub Total
Total

137000
149000

Net worth

189300

Balance sheet
It shows the financial status of a business at a given point of time. It provides a
snapshot and may be regarded as a static picture. It is a systematic listing of all assets and
liabilities of the business. Its purpose is to reveal liquidity, solvency and wealth of the
business of that particular movement( table 16)
Income Statement
It is also called profit and loss account. It is the accounting report which
summaries the revenues, expenses and difference between them (or net income) for an
accounting period. Technically, the income statement is an adjunct to the balance sheet
because it provides details relating to the net income, which represents the change in
owners equity between tow successive balance sheets plus dividends. Yet in practice it is
often considered to be more important than the balance sheet itself, because the details of
revenues and expenses provided in the income statement shed considerable light on the
performance of the business. ( table 17)
Table 17. Income statement of a farm for the year 200 5-2006
Sl.
No.
I
1.
2.
3.
4.
5.

II
III
IV
V

Source of income
Cash farm Income
By sale of
Paddy
Banana
Tomato
Milk
Poultry bird
Sub total
Net capital gain
income
Total farm income
Off farm income
Non farm income
Total income

Amount
in Rs.
8000
5000
3000
5000
500
21500

Sl.
No.
I
1.
2.
3.
4.
5.

1000 II
22500
1000
2500
26000

III
IV
V
VI
VII
1.
VIII
IX

Expenses

Amount
in Rs.

Variable Cash Expenses

Cost of feed
Cost of seed
Cost of diesel
Cost of labour
Cost of fertilizers
Sub total

1500
2000
500
2000
1000
7000

Fixed cost

300

Loan
Total cash expenses
Non cash adjustment
Total farm expenses
Capital investment
Implement
Family expenditure
Total expenses

2000
9300
600
9900
300
7000
17200

Fund Flow Statement

It shows the sources of funds and allocation of funds during the period. It is also
referred as the statement of changes in financial position or statement of sources and uses
of funds, it draws on the information contained in the basic financial statements. Fund
flow analysis provides an insight into the movement of funds and helps in understanding
the changes in the structure of assets, liabilities, and owners equity. ( table 18)
Table 18. Cash Flow Statement of a Farm for the year 2005-2006
Sl.
No.
I
II
1.
2.
3.
4.
III
1.
2.
3.
4.
5.
6.
7.
IV

Particulars
Beginning cash balance
Cash in flow
Sale of crop products
Sale of milk
Sale of poultry
Loan received
Sub total
Cash outflow
Cultivation expenses
Maintenance of livestock
Insurance
Tax
Repayment of loan
Purchase of calf
Purchase of implement
Sub total
Ending Cash Balance

(in Rs.)

JulySeptember
1000

OctoberJanuaryDecember
March
2500
8000

April June
8000

3000
3000
6000

5000
3000
8000

3000
500
3500

3000
3000
6000

1500
1500
---1000
500
4500

1000
1500
-----2500

2000
1500
-----3500

500
1500
200
300
2000
--4500

2500

8000

8000

9500

Financial Ratio Analysis

A ratio is defined as an arithmetic relationship between two figures. The study of
relationship between various items or groups of items in the financial statements is
known as financial ratio analysis.
Financial ratios have been classified into
a)Liquidity ratios b) Solvency ratios c)Turn over ratios and d) Profitability ratios

Liquidity Ratios
Liquidity refers to the ability of the firm to meet its obligations in the short run,
usually period of one year. Liquidity ratios are generally based on the relationship
between current assets (the sources for meeting short term obligations) and current
liabilities. The important liquidity ratios are
i) Current ratio ii)Acid test ratio and
ii) The bank finance to working capital gap ratio
Current Ratio
Current ratio is a very popular financial ratio, measures the ability of the firm to
meet its current liabilities. Current assets get converted into cash in the operational cycle
of the firm and provide the funds needed to pay current liabilities. Normally higher the
current ratio, the greater the short term solvency. A firm with a high proportion of current
assets in the form of cash and accounts receivable is more liquid than one with a high
proportion of current assets in the form of inventories, even though both have the same
current ratio.
Current ratio = Current assets / current liabilities
Acid Test Ratio
Acid test ratio is called quick ratio, is a fairly stringent measure of liquidity. It is
based on those current assets which are highly liquid. Inventories are excluded form the
numerator of this ratio because they are deemed to be least liquid component of the
current assets. Quick assets are defined as current assets excluding inventories.
Acid Test Ratio = Quick assets / current liabilities.
Solvency
It is defined as what the owner would have left after all assets were converted to
cash and debts are cleared. It is a measure of financial security and firms ability to meet

long run claims of the firm/corporation. The important ratios are leverage ratios and net
capital ratio.
Leverage Ratio
Leverage ratios measure the use of debt finance, which represents borrowed
funds. Leverage ratios help in assessing the risk arising from the use of debt capital.
Common leverage ratios are: 1) Debt equity ratio, 2) Debt-assets ratio 3) Interest
coverage ratio and 4) Cash flow coverage ratio.
1) Debt-Equity Ratio = Debt / Equity
Where
Debt = all liabilities (short term as well as long term)
Equity = net worth plus preferred capital
In general, the lower the debt-equity ratio, the higher of protection enjoyed by the
creditors.
2) Debt-Assets Ratio = Debt / Assets
Where,
Debt = All liabilities (short term as well as long term)
Assets = Total of assets in the balance sheet.
Lower the ratio higher the leverage
3) Interest Coverage Ratio
It gives the idea about the ability of a firm to pay interest. A high interest coverage
ratio means that the firm can easily meet its interest burden even if earning before interest
and taxes suffer a considerable decline.
Interest coverage ratio = Earnings before interest and taxes / Debt interest
4) Cash Flow Coverage Ratio
This ratio measures debt servicing ability adequately because in considers both
the interest and the principal repayment obligation.
Cash flow coverage ratio = Earnings before interest and taxes + Depreciation / Debt
interest + Repayment of loan / 1- Tax rate

Net Capital Ratio (NCR) = Total assets / Total liabilities

Higher the ratio, the firm or corporation is having sufficient assets to pay ratio liabilities.
Turnover Ratios
It is also called activity ratios or asset management ratios, measure how efficiency
the assets are employed by the firm. The significance of turn over ratios are given in the
table. 19
Table 19: Turnover Ratios
Sl.
No.

Ratio

Formula

Inventory
Ratio

Turnover Net
Sales
Inventory

Average
period

collection

Receivables turnover
ratio
Fixed asset turnover
ratio

4
5

Total assets turnover

ratio

Inference

/ It measures the efficiency of

inventory management higher the
ratio more efficient and vice
versa.
Receivables
/ It shows the efficiency of
Average sales / receivables management normally
day
average collection period should
not exceed one and half times
credit period.
Net
sales
/ Higher the ratio shorter the
receivables
collection period
Net sales / fixed Higher the ratio higher the degree
assets.
of efficiency in the use of fixed
assets.
Net sales / Total This ratio measures the efficiency
assets
of assets employed. Higher the
ratio higher the degree of
efficiency in the use of assets.

Profitability Ratios
Profitability reflects the final result of business operations. The important ratios
and their significance are given in the table 20.

Tables 20. Profitability Ratios

Sl.
No.
1

3
4

Ratio

Formula

Inference

Gross
profit Gross profit / This ratio indicates the margin left after
margin ratio
Net sales
meeting manufacturing costs. It measures
the efficiency of production as well as
pricing.
Net
profit Net profit / Net This ratio shows the earnings left for
margin
sales
stockholders as a percentage of the net
sales. It measures the overall efficiency of
production,
administration,
selling,
financing, pricing and tax management
Net income to Net income / This Measures how efficiently capital is
total assets ratio Total assets
employed
Return
on Earnings
It is a measure of business performance
investment
before interest which is not affected by interest charges and
and taxes / tax payments.
total assets
Return of equity Equity
It is a measure of the profitability of equity
earnings / Net investment which represents the ownership
worth.
capital

Chapter 14
Farm Investment Analysis
Time Comparison Principle
Farm management is a dynamic one and a farmer often has to take decisions over
varying horizons of time. The two aspects of such decision where time plays a major role
in decision making are
i.

Differences in costs and returns due to time and

ii.

Risk and uncertainty.

First we consider the difference in cost and returns, a farmer is faced with several
decision over time. For example he has to decide.
i.

Whether to invest in annual crops or perennial crops.

ii.

Whether to invest surplus funds in a bank or machines.

iii.

Whether to buy a new machine or second hand machine.

The above questions can be answered if we know the amount available with the farmer
and the future. An amount available after one year is not equal to the same amount today
ie. Rs.100 received after 1 year is not equal to 100 rupees received today. Hence when
costs and returns are distributed over to different periods, they should be reduced to
present values for meaningful comparison. The process of finding the present value of
future sum is known as discounting.
Pt
Po
= --------------------(1+r)1
Po = present value, Pt Future sum at time t
r = rate of interest
Comparison of Two costs over time
Like returns, two or more costs can also be compared over time by discounting
them to their present value:

The objective of farm-firm is to maximize profit continuously over a planning

horizon. Major investment decisions are complicated by time element. Planning horizon
varies with individual farmers.
For the entire planning horizon three basic variations can be introduced
1. Varying the amount of one input and output simultaneously
2. substituting one input for another, and
3. substituting one output for another
Under the above variations, the following are the conditions for profit maximization.
(table 21)
Table 21.Conditions For Profit Maximization
1

Necessary condition
MP of any factor with respect to every
product must be equal to the ratio of
their unit discounted prices
Px
y
= ------ = -------Py
x
The rate of technical substitution
between any two inputs must be equal to
the ratio of their per unit discounted
prices
Px2
X1
= ------ = -------Px1
X2
The rate of product transformation
(RPT) for every pair of products must
be equal to the ratio of their per unit
discounted prices
Py2
Y1
= ------ = -------Py1
Y2

Sufficient conditions
There must be a diminishing marginal
product of a factor with respect to a
product. (MPP diminishing)

The rate of technical substitution

between inputs must be diminishing
(MRTS diminishing)

The rate of product transformation

(RPT) between two products must be
increasing.

In addition to the above set of conditions the present value of the stream of profits over
the planning horizon must be positive. It may be noted that all the conditions of profit
maximization of the static case hold here.
Capital Budgeting

Capital budgeting refers to the long term planning involving the proposed capital
outlays and planning.
Capital budgeting is the firms process of decision making for the acquisition and
investment of capital, involving various step like the estimated financial outlay, formal
plan for purchase of fixed assets, estimation of expected cash flow etc.
Need for Capital Budgeting
It has long-term consequences. Capital investment decisions have considerable
impact on what a firm can do in the future.
It is difficult to reverse capital investment decisions because the market for used
capital investments is ill-organized and / or most of the capital equipment bought by a
firm is tailored to meet its specific requirements.
Capital investment decision involve substantial outlay.
Capital Budgeting Process
It is a complex process which may be divided into following phases;
i) Identification of potential investment opportunities
ii) Assembling of proposed investments
iii) Decision making
iv) Preparation of capital budget and appropriations
v) Implementation and
vi) Performance review
Use of Capital Budgeting
1. It determines the capital projects on which work can be started during the budget
period, after taking into account their urgency and the expected rate of return on
each project.
2. It determines the expenditure that would have to be, incurred on capital projects
approved by the management with sources.
3. It restricts the capital expenditure on projects within authorized limits.
4. It enables the investment proposals to be taken up as a single package.
Defining Costs and Benefits

Capital expenditures generally involve current and near future costs which are
expected to yield a flow of benefits in the future. In evaluating a capital expenditure
proposal two broad phases are involved.
Defining the stream of costs and benefits associated with the investment.
Appraising the investment to determine whether it is worthwhile or not.

Investment Analysis
Investment analysis deals how a limited supply of capital should be allocated
among alternative uses. In the context of commercialization of agriculture cash outlays for
capital purchases are increasing and consequently capital investment decisions are
graining importance. But the decision making on capital acquisition has become
difficult since in most of the investments, expenditure is made in the present while the
benefits accrue over a period of several years in the future.
Capital investment decisions primarily involves four types:
i).

Identifying potentially profitable investment alternatives

ii).

Collecting relevant data on capital outlays, costs and returns

iii).

Using an appropriate method to analyse the data

iv.)

Deciding whether to accept or reject the investment or selecting the top

ranking among mutually exclusive projects.

There are several ways the data on the performance of an investment project on be
analyzed. Regardless of the specific method used, capital investment analysis requires
accurate data on costs and returns. The validity of the result depends upon the quality of
data and hence every effort should be made to obtain realistic estimates of costs and
benefits.
The method used in investment analysis are broadly classified into two categories
a. Undiscounted methods; and
b. Discounted methods

A.) Undiscounted Methods

i) Ranking by Inspection:

With the same investment, two projects produce the same net income, but one
continues to earn longer than other will be selected (or) in others instances, for the same
investment, the total net value of production may be the same, but one project has more
of the flow earlier in the time sequence will be selected. The project which yields higher
total net cashflow will be selected.
Advantages: Simple to Workout
Disadvantage: Ignores time value of money. Projects cannot be accepted fully based on
this method. More elaborate analysis is necessary.
ii) Payback period
Pay back period is the time required for the stream of cash inflow of an
investment to equal the initial project outlay i.e. the time required for the project to pay
itself out. The project which bears quick payback will be selected.
Advantages: The main advantages of this method is its simplicity. Since this method
emphasis on quick cash recovery it is suitable for project with uncertain future returns.
Disadvantages: This method fails to consider the earnings received after the payback
period. It does not account for the timing of cash flow and time value of the money. Also
there is no logical or theoretical basis for fixing a meaningful payback period.
iii) Proceeds per unit of outlay
Investments are sometimes ranked by the proceeds per unit of outlay which is the
total net value of incremental production divided by the total amount of the investment.
Advantages: Simplicity, takes into account entire stream of cash flows.
Disadvantages: Ignores time value of money and payback period.
iv) Average annual return
If the annual average proceeds per rupee of outlay is expressed in percentage it is
the annual return.

B. Discounted Methods
Discounted methods account for the time value of money. The three important
discounted methods are Net Present value (NPV), Benefit-Cost Ratio (B-C ratio) and
Internal Rate Return (IRR).
i) Net present value (NPV)
NPV is the difference between the sum of discounted benefits and sum of
discounted cost. A project is acceptable if the NPV is positive.
ii) Benefit cost ratio (B-C ratio)
It is the ratio of sum of discount benefits to discounted costs.
Sum of Discounted benefits
B-C ratio = -----------------------------------------Sum of Discounted costs
A project to be acceptable, if BC ratio should is greater than one.
iii) Internal rate of return (IRR)
IRR is also referred to as discounted rate of return or yield of an investment. IRR
is the discount rate which makes the net present value equal to zero or IRR is the discount
rate which makes the Discounted benefit equal to Discounted cost.
IRR is found out by trial and error method. Initially two discount rates one which
results in a positive NPV and the other one which results in a negative NPV is found out.
Discount rate with positive NPV is called lower discount rate and the discount rate with
negative NPV is called higher discount rate. From these lower and higher discount rates
IRR is worked out using the formula given below:
IRR = Lower
discount +
rate

Difference between
Lower and Higher
Discount rate

NPV at lower discount rate

---------------------------------------Absolute difference of NPV at
Lower and higher discount rates

IRR is the true rate of return. If the IRR is greater than the opportunity cost of
capital or a specified rate by financial institutions the project will be accepted.
This method is the best method.

Chapter 15
Farm Planning and Control
Farm Planning and Budgeting
Economic planning involves allocation of limited resources among alternative
opportunities in order to satisfy the objectives. Any planning process contain three
essential components.
1. An objective
Production economics assumes maximization of profit as the goal. Farmers may
have other goals also. These goals are achieved not by abandoning the profit maximizing
principle, but by including personal or managerial constraints.
2. Resources and constraints
The resource available to the farmer act as a frame work with in which he must
plan his system of farming. The resources available to the farmer distinguish the feasible
from the infeasible enterprises. The fixed resources place a limit on the maximum level of
production from individual enterprises. The quantity and quality of fixed resources also
influence the level of variable resources used. Resource constraints can be divided in to
major categories such as land, labour, capital, personal, institutional and husbandry
constraints. The first three represents material resources and the last three represents non
material resources.
a) Land

It is a complex resource influencing farming through its location, through natural

factors associated with it such as soil type, fertility, topography, drainage, water etc. It is
common to find more than one category of land at the same farm. The land can be
divided into homogenous plots considering the soil characteristics.

b) Labour
In the case of crop production labour constraints operate through peak periods.
c) Capital
Both fixed and working capital may act as constraints. Buildings, machineries are
fixed capital. Liquid capital is required to pay for variable inputs, to service the fixed
capital, paying taxes, insurance premium and for family expenses.
d) Personal and family constraints
Constraints such as attitude towards risk, (willingness to accept risk),
requirements of the family such as grains, fruits, vegetables, milk etc., farmers subjective
preference for an enterprise, act as constraints in achieving the goals.
e) Institutional constraints
These arise from factors operating outside the farm and are concerned with the
policies of the Government, marketing and credit institutions.
f) Husbandry constraints
These are concerned with preserving the long term fertility and condition of soil,
controlling the diseases so that sustainability can be maintained. For example, allocating
some area for green manure / legumes, keeping land fallow.
3. Enterprises
This represents alternative ways of using the resources to attain the objectives.
The following information about the enterprises are necessary for planning.

1. Requirements of fixed inputs land, buildings, machine

2. Requirements of variable inputs
3. Financial returns.
The maximum size of an enterprise depends on the amount of fixed resource required /
unit of the enterprise and the total amount of the fixed resource available.

Max. size of enterprise

Total fixed resource

-------------------------------------------Fixed resource per unit of enterprise

Farm Plan
A farm plan is a programme for the organization and operation of a farm. It is a
blue print of a set of proposed actions to be taken for a given period to achieve a specified
goal(s). Farm planning and budgeting are the physical and financial components of farm
decisions. Planning is the process of preparing plans ie, it is the process of allocating
scarce resources among competing alternatives to achieve a goal (s). Farm planning is a
continuous process since farmers operate the business in a dynamic environment. In
response to changes in resource availability, technologies, input and output prices
Government policies and institutions farmers have to alter existing plans or prepare new
plans.
Budgeting
Budgeting is a method used to analyse the probable effect of the farm plan on
costs and returns of the farm business. When coupled with cash flow analysis, budgeting
gives a good indication of profitability and cashflow feasibility. It is better described as
an aid to rather than a method of farm planning. Planning without estimating expenditure
and income is not of much use. So farm planning and budgeting go side by side.
In the short run farm plans do not alter farm structure and used to optimize the
resource use with given resources and environment. In the long run farm plans alter the
farm structure such that the constraints are relaxed or removed and farm growth is
generated.

The primary purpose of farm planning and budgeting is to improve the

organization and operation of the farm. It is useful in (1) Diagnosing farm business
problems (ii) improving the economic efficiency of farm business (iii) planning for the
resource requirements.
Today, farmers live in a dynamic world. Technological, economic and institutional
changes made farming system in many regions of the world obsolete and there are
maladjustments in the organization and operation of farms. To determine the changes or
adjustments which are needed, farm management research workers rely on the technique
of farm planning and budgeting. There are two types of farm budgeting viz., (i) partial
budgeting and (ii) complete budgeting.
Partial budgeting
It is commonly used to estimate the costs and returns of making relatively small
changes in the existing farm organization. It does not consider the farm as a whole and
estimates the cost and returns for a part of the farm business. There are three main types
of change.
1. Factor substitution
Here the term factor is used in the widest sense. Often a change in production
techniques is involved i.e., substitution between inputs. Examples are using power
sprayer instead of hand sprayer, using tractor instead of bullocks for ploughing, foliar
application of nitrogen instead of soil application, using complex fertilizer instead of
straight fertilizers, chemical weeding instead of hand weeding, combine harvester instead
of human labour.
2. Product substitution
Here one enterprise is substituted for other. Examples are replacing local variety
of a crop with High Yielding varieties. Replacing a crop with another crop.
3. Adding a new enterprise without substitution

A new enterprise is added without replacing the existing enterprises. Examples

are: adding a few milch animal or birds, a green manure crop in fallow lands.

Four questions are considered in partial budgeting, two of which relate to

financial losses from the contemplated changes (debit) and other two relate to the
consequential financial gain (credit). Only those changes in costs and returns as a result
of contemplated change are considered. Both fixed and variable costs relate to the change
have to be considered. Using these values partial budget has to be prepared and the
format given (table 22)
Table 22.Partial Budget Format
Debit
Amount
Credit
Amount
1) Increased (added) cost
1. Increased (added) return
2) Reduced revenue
2. Reduced cost
---------------------------------------------------------------------------------------Total
Total
----------------------------------------------------------------------------------------If the credit is greater than debit the proposed change can be effected.
Enterprise Budget
A commodity that is being produced on the farm is called farm enterprise. Farm
budgets can be developed for each potential enterprise. Enterprise budgets are prepared in
terms of a common unit i.e., acre, hectare, for a crop, one head of livestock, etc. This
facilitates easy comparison between the enterprises. Enterprise budget is the estimation of
expected income, costs and profit for an enterprise.
Enterprise budget is a convenient means of summarizing enterprise cost and
return projections for use in many management decisions such as selecting a process to
produce a crop / livestock, developing leasing arrangements / choosing appropriate
investment / preparing whole farm plan. Hence it is necessary for farmers to frequently
estimate costs and returns for future periods of time. A projection of average cost and
return for an enterprise is commonly referred to as enterprise budget or a gross
margin calculation. An enterprise account is a summary of costs and returns for some

historic period such as the past year or an average of several years. It is obtained from the
records of the business. An enterprise budget is a projection of costs and returns for some
future period, such as the coming year. While enterprise accounts may be useful in
preparing enterprise budget, they seldom provide all of the data needed. Even the
operator who expects to produce the same enterprise using the identical system of
production may expect different input prices, product prices, and for production levels in
the future than prevailed in the past. The change in prices may suggest a different
combination of variable inputs and timing of production to improve profitability.
Whole Farm Planning And Budgeting
Complete budgeting relates to the entire farm business and all costs and receipts
have to be estimated.
Steps in whole farm planning and budgeting
1. Setting of goals
The identification of family and business goals is very important. Family goals
are influenced by family values (religious belief, social value system etc) and family
circumstances (age, health, skill, education level etc.) Business goals are influenced by
business values (high profitability, growth, liquidity etc) and business circumstances
(existing social, economical, technological and institutional conditions).
The family goals that coincide or do not conflict with business goals are the
relevant family business goals which can be used in planning.
2. Inventory of Resource availability
Inventory of resources such a land, labour, capital (building, machinery, liquid
capital etc) will help to assess the resource limitation and production capabilities of the
farm. The possibilities of renting, hiring and borrowing of resources may also be
considered.
3. Identification and selection of alternatives to be analysed
In forward planning, analysing alternatives is of great importance. Lack of
information and knowledge limit the alternatives one might consider.

4. Selection of input information to be used in the analysis process

Once the alternatives have been selected the next step is to specify the input
output relationships. It is concerned with the quantity, the quality of inputs needed to
achieve a certain level of output. It is important to consider the fundamental economic
concepts in deciding the input and output levels.

5. Selection of prices to be used in the analysis process

Once the input relationships have been established, price must be considered to
evaluate the economic consequences of the proposed alternative or adjustment. Product
prices may be some what more difficult to estimate that input prices because of wide
fluctuations.
6. Analysis of various alternatives
In this final step of forward planning each of the alternatives under consideration
is analyzed. Analysis involves selecting the appropriate analysis technique and evaluating
the positive and negative aspects of each alternative. Partial and whole farm budgeting
can be used to analyze the alternatives.
7. Comparing the alternative plans
The alternative plans are compared and the best one is chosen considering
sustainable and long development of the farm.
Important reasons for making farm plans
1) It enables the farmer to achieve his objectives in relation to his farm and family in
a more organized manner. The process of farm planning may also encourage him
to develop and gather new ideas about farm practices with a view to achieve the
stated objectives.
2) Farm planning enables a careful examination of the existing resources and their
best allocation for achieving higher resource use efficiency, farm income and farm

family welfare. Thus it helps maximizing efficiency and family satisfaction and
minimizing the wastes.
3) A good farm plan serves as a basis for a judicious combining of the existing and
new alternative enterprises. It is a continuous process wherein relatively more
profitable new enterprises keep on replacing the old and less profitable ones over
time.
4) Supply needs of input can be identified reasonably ahead of time and adequate
arrangements made for their procurement.
5) The expected incomes can be estimated well ahead of time. It helps the farmers to
initiative steps for procuring the required credit. Also, investment opportunities
can be planned depending upon the surplus of expected incomes at some future
point of time.
6) A good farm plan helps to prevent many of the stresses and strains in the business
of farming through orderly planning.
7) A properly thought of farm plan may provide cash incomes at points of time when
they may be most needed at the farm.
8) Above, all, a farm plan acts as useful money saving device. It is always cheaper to
commit mistakes on a paper than in the business.
Characteristics of a good farm plan
1. The most important characteristic of good plan is that it should be written. All the
minor details about the organisation and operation of farm business should be
clearly outlined.
2. It should be forward looking. An element of flexibility in a farm plan proves
useful in introducing suitable changes in response to variations in the environment
around the farm, farmer and farm family from time to time. Rigidity is contrary to
the very concept of planning.
3. A farm plan should be such that it ensures maximum resource use efficiency at the
farm. It is particularly important in view of the scarcity of resources and the
possibilities of their alternative uses.

4. It should provide for the attainment of both business and farming goals. Such a
combination in turn ensures.
i. Production of food, cash and fodder crops consistent with the objectives of the
farmer.
ii. Prevention of unnecessary stresses and strains in the use of farm resources like
land, labour, power and machinery throughout the year.
iii.Proper crop rotations so as to maintain and improve soil fertility.
iv. A more or less regular flow of income over time rather than only at one or two
points of time in a year.
v. Stabilization of the farm incomes over time; and
vi.Taking care of the likes and dislikes of the farmer, e.g. it may be essential to
include / exclude certain enterprises which may be relatively more /
less profitable.
vii.

Conservation of vital resources such as soil and water to make farming

sustainable in the long run.

5. Risk and uncertainties can be accounted for in good farm plan. Thus it should help
the farmer to avoid the chances of large losses due to risk and uncertainties or
complete ruin during bad times through wise planning.
6. A good farm plan is one which optimizes the use of the existing body of
knowledge, training and experience with the farmer. It ensures minimization of
under utilization of the personal resources and ability of the farmer.
7. It should provide periodical details about the inflow and outflow of funds. Thus it
helps in timely procurement and repayment of farm credit.
8. An ideal farm plan also gives due consideration to the marketing arrangements for
farm inputs and farm products.