Need Vs. Want: When to Make That Big Purchase
Jul 08, 2013
A few simple tactics that can help you better organize your dairy’s capital budgeting.
By Matthew Lange, AgStar Financial Services
Consider the last capital purchase you made on your dairy. Was it necessary? Did you buy at the best price and at the right time? How do you know?
Land, buildings, and equipment all make up major capital purchases, and it’s important to understand their impact on the operation before pulling the trigger.
Capital purchases are filled with many variables, making decisions surrounding them sometimes feel chaotic and discomforting. Major projects, such as a new feed pad, get put on hold for another year because of unplanned engine overhauls and worn out equipment in the parlor taking up the money. Sometimes producers feel compelled to make a decision today in order to get a "good deal" on a new piece of equipment, even though the purchase is not a necessity at that point in time.
First of all, when considering a capital purchase, it’s important to identify the impact it will have on your business. This is the basis for any capital decision. Any new investment in your dairy operation must meet at least one of these major criteria:
• Is the purchase a replacement for poor performing, existing equipment?
• Will the purchase increase efficiency within the operation?
• Or, is this purchase part of an expansion project enabling you to meet growing needs?
Needs-based purchases take priority over wants, but given the right circumstances, wants that meet one of the three criteria can also be beneficial to the business.
Employing a few simple tactics can help you better organize the many questions surrounding capital budgeting.
1. Identify and prioritize needs and wants. Begin by developing a list of capital expenditures that are:
B.) important but not urgent, and
C.) those that you need more time to consider.
Urgent expenditures, such as buying new fans for the barn or getting a new manure pump, become priorities for the next 12 months. Important, but not urgent, expenses will be made within the next three years. Anything beyond this point is an idea of a possible purchase, but has no immediacy. By prioritizing, you are helping identify the "needs" vs. the "wants," while planning for both. Be sure to include a buffer for unexpected purchases that may occur as well as a cost overrun on building projects — approximately 10% of the total overall cost.
2. Determine when the purchase will be made. Timing your capital purchases is critical to managing cash flow, taking advantage of special offers from dealers, and knowing definitively how an unplanned purchase may impact the rest of your planned purchases. Pull out the calendar and your urgent purchase list and decide when the purchase will occur. This may be based on availability on a line of credit or when construction of a particular project can commence or on a whole host of other issues. Getting the urgent purchase on the calendar sets a time frame and helps your business stay on track with its budget.
3. Evaluate financing options. It is critical to manage your purchasing power and provide yourself with financial and decision-making flexibility for future purchases. While you might have your sights set on building a transition barn or making major upgrades to the parlor, will it limit your ability to purchase that 160-acre tract down the road your neighbor is thinking about selling in the next two years? Knowing how you intend to finance each of your capital expenditures (cash, revolving line of credit) will improve your ability to maximize buying power and take advantage of opportunities. Above all, discuss these items with your lender to better understand how they will impact your business, cash flow and ability to be flexible and nimble when opportunity knocks.
4. Managing the asset. Lastly, consider how you will manage the asset to obtain its greatest value. For example, repair costs, hours of use, and job functions all impact how you will manage a skid steer, impacting when it will be time for its replacement or upgrade.
There’s a lot that goes into determining whether or not a capital purchase makes sense. What’s right for one producer at any given time may not be right for another. Taking emotions out of the equation and objectively analyzing the pros and cons for your specific situation will help alleviate some of the confusion. Likewise, utilizing the strategies outlined above and budgeting for capital expenditures will enable you to plan better and get the most of your purchase.
Matt Lange is a business consultant providing dairy and financial management expertise to dairy producers and managers. He holds an M.S. in Agricultural Economics from Purdue University and a MBA from Indiana University. Contact him at Matt.Lange@agstar.com.For more information and other content like this, check out AgStar’s Dairy Blogs and educational offerings on AgStarEdge.com.