A combination of these four factors: technology advancements, economies of scale, timing and value, help Matt (left) and Mike Allyn make the best equipment purchase decisions for their southern Indiana farm.
This past August, as Mike and Matt Allyn evaluated whether to purchase or lease the gleaming yellow combine that now sits in their machine shed, they seesawed back and forth between the pros and cons of each option. After crunching the numbers multiple times, they decided to buy.
“We agonized over the decision,” says Mike, who notes the purchase was the largest one-time capital expenditure the twin brothers have made to date for their southern Indiana grain farm, based near Mount Vernon.
“Machinery costs are a 1,000-lb. gorilla,” he adds.
That’s true for most farmers, says Kevin Dhuyvetter, Kansas State University Extension economist. “It’s not the sexiest topic, but knowing where you stand on machinery costs—whether this is a strength or weakness of your business—is extremely important,” he says.
That fact was reinforced by a five-year study of enterprise data from the Kansas Farm Management Association completed in 2007. Dhuyvetter and other economists analyzed the
results and determined that a farmer’s ability to manage machinery costs effectively often indicates whether his operation is a high-profit or a low-profit one.
High-profit farms in the study had, on average, $31 per acre less in annual machinery costs than low-profit farms. In total, machinery costs accounted for about 33% of the difference between high-profit farms and those with low profits. A recent update of that study, looking at the last three years (2007 to 2009), reinforced the earlier results.
Dhuyvetter attributes much of the cost difference to farmers’ individual management styles.
“I can’t control grain prices, but with focused attention I can impact machinery purchases and repairs,” he says. “When you look at profit differences in a given year, prices are important. But when you look at longer time periods, cost control—especially machinery costs—becomes very important.”
Weigh your options. Whether farmers will benefit from buying or leasing equipment is a question that can only be answered on a case-by-case basis.
Leasing can be a good decision if your operation fits one of these scenarios: you need to preserve capital; you plan to expand or reduce the size of your operation; or you plan to retire.
“When someone says I need to lease, my initial reaction is they’re not doing their analysis correctly,” Dhuyvetter says. “In most of the analyses I’ve done, you’re usually a few thousand dollars better off to buy, but I’ve learned that’s not always true. Sometimes the difference is negligible, and there are cases where leasing is better.”
He adds that two important parts of the purchase-or-lease equation are whether you have a good credit score and a sizable down payment.
“Leasing is often easier to get into because there is less money required up front, but you might be paying a higher effective interest rate. That is why it is important to analyze the alternatives correctly,” Dhuyvetter says.
Tax consequences should also figure into farmers’ decision-making. Dhuyvetter says farmers in high tax brackets need to evaluate Section 179 of the tax code to determine whether they can write off their machinery costs when purchasing equipment.
“Once you’ve made the decision to buy or lease machinery, you need to finance it in the most profitable way,” he says.
The Allyn brothers, who farm with their father David, now base their equipment purchase decisions on some combination of these four factors: technology advancements, economies of scale, timing and value.
To evaluate the latter, especially, they use linear programming software developed by Purdue University.
“We plug in our variables, such as number of employees, acres, crops, machinery sizes and cost rates, and the program will then identify any bottlenecks or potentially limiting factors,” Matt says.
Bruce Erickson, director of cropping systems management for Purdue, says the computer-based program is available to farmers who participate in the university’s Top Farmer Crop Workshop held each July. But there are aditional machinery resources available on the Purdue Web site.
Technology pays. Dhuyvetter says the farmers he works with try to stay within two to three generations of the most current technology. He contends that is not a sound strategy any longer, especially for larger operators. Some of the input-saving features of today’s machinery, such as section controllers on sprayers and row shutoffs on planters, pay for themselves quickly.
“You need to invest in these technologies if you want to stay competitive,” Dhuyvetter says.
Erickson agrees, but cautions that some farmers become so enamored of new technology that they upgrade too soon. “If you buy a huge combine but don’t have the ability to get the grain carted away from it quickly, it doesn’t pay to have all that capacity,” he says.
Instead, farmers need to evaluate whether their equipment flows together well as they move from one process to the next, Erickson says.
The Allyns use this strategy when assessing their equipment needs. “You have to work backwards,” Mike says. “Start with your planter. If you know how much you need to plant per day, then you know what size of tillage tools you need. Likewise, in the fall, you have to know how many acres you need to harvest. Working backwards, you can evaluate the size and number of weigh wagons, trucks, tractors and other equipment you need.”
With a positive outlook for 2011 prices and farm income, Dhuyvetter looks for equipment purchases and leases to continue their upward trend, along with equipment prices.
University of Illinois ag economist Gary Schnitkey agrees. He says 2009 capital investments, in machinery specifically, were approximately $85 per acre—more than double what they were only five years ago. He adds that farmers can expect equipment depreciation costs to increase, too.
“Market depreciation is one of the biggest factors we take into consideration,” Mike Allyn says. “You can buy something today and next year it’s gone down in value.”
Repairs can also eat into that value. According to Schnitkey’s research, repair costs have increased since 2005 from $17 per acre on average to $24 per acre, a 41% gain.
For some farmers, neither buying nor leasing is the best option. Instead, Dhuyvetter says, hiring custom help may be the way to go. Past research has shown producers’ costs can be 25% to 30% higher than average custom rates. “Know your costs and how you compare with others in the area,” he says.
Timeliness and quality of work are still big factors. “If I can get 5 bu. to 10 bu. more per acre, that wipes out the fact that custom work might have been lower-cost,” Dhuyvetter says.
Mike Allyn likes Dhuyvetter’s ideas about hiring custom work, but says it’s not a feasible option for their southern Indiana operation. “Our choice is to either buy or lease,” he says. “So far, owning has been the way to go.”
- University of Illinois ag economist Gary Schnitkey says 2009 capital investments, specifically machinery, were about $85 per acre, more than double what they were five years ago.
- Schnitkey adds that repair costs since 2005 have increased from $17 per acre to $24 per acre, a 41% gain.
- Kansas State University Extension economist Kevin Dhuyvetter says two important parts of the purchase-or-lease equation are whether you have a good credit score and a sizable down payment.
- Mid-November 2010