Best if printed in landscape.

Enterprise Analysis

Reference pages:

• Description
• Sample format
• Example of completed enterprise budget
• Description of an Integrated Enterprise Analysis

As stated in another section, an income statement is used to calculate the amount of profit a business generates during a time period, such as 3-months, 6-months, or annually.  The basic formula for profit (and thus the general categories of an income statement) is revenue (the value of the product produced during the time period) minus cost (of the inputs used to produce that products during that time period). 

Managers, in order to make decisions, need more detailed information.  It is important to know the overall profit of the business (thus an income statement), but the manager also must know which components of the business are generating profit.  The purpose of an enterprise analysis is to determine the profit for a portion of a business.  Enterprise analysis is looking at individual pieces, components or enterprises in the business to determine whether that piece of the business is profit, and whether that piece can be altered to increase its profitability.

This section addresses enterprise analysis, that is, determining the profitability of a part of the business.

• A challenge in conducting an enterprise analysis is that it involves several economic/managerial concepts, including income statement, record keeping, using public data, production response (production function, variable inputs and cost, fixed inputs and cost, level of output, revenue), depreciation, economic resources, opportunity cost, goals, and cash flow.
  • Why analyze a business as several enterprises rather than as a whole business?
• Resource:  Kay, et al. Farm Management, McGraw Hill, 5th Ed. 2004, chapter 10.
• Resource:  U. of Illinois.  Enterprise Allocation and Analysis; also see Enterprise Allocation and Analysis at farmdoc FAST Tools.

• Like an income statement, an enterprise analysis determines profit.  Unlike an income statement, an enterprise analysis determines the profit for one segment (one enterprise) of the business; an income statement determines the profit for the entire business.
  • How does preparing an enterprise analysis relate to the concept of production response? An enterprise analysis summarizes the relationship between quantity of inputs and quantity of output or production for that part of the business.
  • Is it appropriate to describe an enterprise analysis as representing one point on the production function, and altering the enterprise analysis as representing another point on the production function?   More on this in the section titled "Diminishing Marginal Productivity".

• This also may be an appropriate time to remind ourselves that the revenue component of an enterprise analysis directly reflects the business’ marketing practices.  Even though this discussion does not address marketing in detail, it is critical that managers recognize how these discussions relate to topics addressed by other disciplines.

• Use an enterprise analysis to determine whether the activity or segment of the business is profitable.
  • A challenge in conducting an enterprise analysis is allocating costs among several enterprises that each use the resource, such as labor (e.g., manager's time), machinery (such as a tractor or truck), or business facility and overhead (such as shop, utilities).
  • For example, review the concept of depreciation; how does a manager allocate depreciation cost among enterprises?

• Use an enterprise analysis to assess a new alternative for a business, rather than a partial budget (described below), only if the alternative will have no impact on the existing operation.

• Use an enterprise analysis to compute the cost of producing the output; for example, the cost of producing a bushel of grain or the cost of providing a service.  This "per unit" cost of production information can be used when developing a marketing plan; that is, the cost of production is the minimum selling price to avoid incurring a loss; or a selling price equal to the cost of production is the "break-even" price.

• Set revenue to zero and include opportunity costs for all owned economic resources to compute cost of operating the enterprise
• Divide total cost of operating the enterprise by projected quantity of production to calculate "per unit" of cost of production or a "break even" price.

• Through appropriate use of opportunity cost, an enterprise analysis can be used to determine the return to one or more owned assets.

• For example, impose an opportunity cost for all owned inputs except land; subtracting those opportunity costs from the accounting profit will reveal the "return to the owned land."
• Such a use of opportunity cost will provide information with which the manager can decide whether the business is generating a return adequate to warrant continuing to use the owned resource in the enterprise.

• Use an enterprise analysis to determine the value of a resource. For example, what is the value of leased land? Assume a manager wants to determine how much can be paid to lease additional land.

• Prepare an enterprise analysis for the land that may be leased.
• Project revenue by identifying the commodity that will be produced on the leased land, the level or quantity of production, and the selling price.
• Identify the production inputs that will be used, the quantity and the cost. This cost calculation must include all costs, for example, depreciation for the equipment that will be used to operate the leased land.
• Do NOT enter a cost for the land that will be leased.
• Enter an opportunity cost for all the owned resources (e.g., labor, capital) that will be used in operating the leased land. Be certain to include an allowance (opportunity cost) to compensate for risk and management.
• Subtract all costs, including opportunity cost, from the projected revenue. The remaining balance is the "return to the land;" that amount could be paid to lease the land.
• The "return to the land" also is a consideration in calculating how much to pay to buy land.   More on this point in the section titled "Time Value of Money".

• A challenge in using enterprise analysis is analyzing enterprises that impact one another, such as a crop rotation, product of one enterprise that is an input for another enterprise (such as raised feed), or an enterprise that has several products  (such as cropland used to raise several crops).

• Excel spreadsheet with simple enterprise analysis form.

Last Updated September 14, 2010

Email: David.Saxowsky@ndsu.edu

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

E-Mail:sswandal@ndsuext.nodak.edu
Published by Agricusiness and Applied Economics
Morrill Room 217
North Dakota State University, Fargo, ND 58105-5636
Phone: (701) 231-7441