By: Vince Bailey, Senior Vice President of Ag Lending | Farm Credit Mid-America
Equipment is a large expense on any operation’s balance sheet. However, outside the initial cash or financing needed to purchase the machinery, there are quite a few other costs equipment can have to your farm. This is why it’s best to plan out machinery purchases well in advance and secure sufficient financing for those purchases to avoid losing money because of financing costs. This is even more critical as the premium on financial efficiency grows for producers beset by bearish markets for the crops they grow.
Here are a few things producers should examine when financing equipment:
- Ensure the equipment being purchased is being fully utilized. Excess equipment can eat up capacity in both the farm’s earnings statement and balance sheet.
- Consider finding a piece of good used equipment that still has a limited warranty instead of buying something new.
- Look for ways to combine equipment, including trading in two smaller pieces for a larger piece that is more efficient and requires one less operator. This could save costs in the long run.
- Weigh if a custom operator or sharing a piece of equipment with another producer is an option. Both of these options can decrease the risk associated with owning the machinery.
- Consider a lease that provides a lower annual payment combined with a limited down payment requiring less cash up front.
Though we always recommend farmers take out an equipment-specific loan to finance their purchase, there are a few, rare cases where producers can potentially use an operating line to finance equipment. Generally, these are situations that are unforeseen and could not be addressed by planning ahead:
Unexpected repairs and replacement. In some cases, a machinery repair or altogether new purchase isn’t part of a larger ownership strategy, therefore it may be more of a surprise to the producer. Using operating credit may be inevitable. In cases like this, it’s important to make sure the price tag isn’t high enough to erode that line of credit that’s normally reserved for things like crop inputs. If a farmer has an unexpected maintenance issue pop up in the field and all the sudden has a $10,000 repair to make, operating lines may be necessary. However, producers should use this option judiciously.
Temporary purposes based on timing. Producers may be able to use operating credit for machinery if they first consider their own liquidity and working capital targets – and only spend cash that is available above that target. For example, if a producer’s working capital target is equal to 25 percent of their gross revenues, which are $2,000,000 then the target equals $500,000.In this example, the producer has $650,000 in working capital and therefore can comfortably spend $150,000 of cash from the operating loan. The advance on the operating line should be replaced with the sale of the current crop.
Equipment will always be a major purchase. By planning ahead, producers can save financing costs and positively impact their bottom line in the near- and long-term future.
For more information on financing your equipment and powering your operation, visit our website.