Strategies for Managing Equipment Expenses
January 20, 2018
Written By Michelle Cummings
Razor-thin profit margins and depleted capital reserves have forced many farmers to re-evaluate the way they manage their machinery. Low prices for corn, soybeans and other commodities have producers looking to cut costs wherever possible. The belt tightening has prompted many farmers to forego replacing much of the farm equipment purchased during the most recent boom cycle, which ended four years ago.
But not all farmers have the luxury of waiting for the market to rebound before they need to make decisions on their machinery. The replacement of aging and under-performing equipment can be put off for only so long.
A Significant Expense
It’s not unusual for farmers in Kansas and the surrounding states to spend approximately 35 to 40 percent of total costs on machinery. With equipment accounting for such a significant chunk of their operating expenses, it’s imperative farmers have a plan to maintain their machinery that fits within their budget.
Gregory Ibendahl, an agricultural economics associate professor at Kansas State University, says farmers can use several strategies to replace equipment, and they all have different effects on cash flow.
“From a profitability perspective, the best strategy is to minimize the long-run cost of equipment by replacing (it) when the annual costs in a given year start to exceed the cost of replacement,” Ibendahl says. “However, in years of low profitability, this approach creates cash flow problems.”
Ibendahl notes most producers in the state of Kansas opt to replace equipment when they have the cash to do so. This approach enables farmers to buy and expense farm machinery purchases in profitable years rather than when cash is tight. The issue with this strategy is that “some equipment might be replaced before it should and other equipment might be replaced past the optimal point of replacement,” Ibendahl says.
While most equipment is still acquired through conventional purchases, leases have become more common.
Leasing is an attractive option in the current state of the ag economy because it allows farmers to control productive assets without owning them. Leasing also guarantees the equipment will be relatively new and have little to no repair costs. The downside is that farmers will have built up no equity interest in the equipment at the end of the agreement.
“For a short-term project, leasing equipment is the way to go,” says Ray Massey, an agricultural and applied economics extension professor for the University of Missouri. “While leasing equipment may be more expensive initially in the upfront cost of payments, it also minimizes liability on a farmer’s balance sheet.”
Although the payments for leasing farm machinery may be higher than when purchasing equipment, farmers can save time and money on the minimal upkeep associated with leased iron.
“Equipment is typically in better shape when leasing compared to renting,” says Alan Utterback, a regional vice president with Sydenstricker, a Missouri-based equipment dealer. “Leasing works well when a farmer is about to retire or when a second combine or planter is needed.”
Farmers looking for a more long-term solution can opt for a late-model piece of used equipment. Buying used iron has become more attractive in recent years as manufacturers have introduced certified used programs with extended warranties. This is typically the approach Terry Ecker, a livestock and row-crop farmer from Elmo, Mo., prefers.
“I like to stock up on equipment when I have a year with more significant cash flow, and I still look for a slightly used option to find a good deal,” Ecker says. “I usually prioritize my everyday machinery purchases, such as what I use for livestock, and postpone buying any seasonal row-crop equipment.”
Three Things to Keep in Mind
Renting Can Make Sense
Rental agreements are good options for machinery that will be needed for only a short amount of time. Regardless of a farm’s financial condition, if the equipment is not likely to be needed regularly, it may be more logical to rent than own. Skid loaders, grain drills, combines and large tractors are some of the most commonly rented pieces of equipment.
Consider the Cost of Ownership
Don’t forget to evaluate the hidden costs with each option. While purchasing used equipment may help cut down on expenses initially, repairs on older machinery can be costly. Leasing equipment is an option for those not wishing to deal with machinery in the offseason nor have a depreciating asset on their hands, while others believe the equity value of amassing more equipment is worth the extra hassle. Receiving a loan for additional equipment and renting are also alternatives offered through many dealers that may allow farmers more flexibility with their financing options.
Keep in mind that investing in used equipment may require more repairs. Depending on the age of the machinery, farmers could be dealing with worn parts that are closer to breaking down. However, farmers with the skill and know-how to repair their own equipment may gain more value out of older pieces of equipment than those who would be paying someone else to fix it for them.