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Depreciation and CAPEX

 

Many people in my seminars are asking questions concerning the proper amounts of depreciation and annual capital expenditures, or CAPEX. Here are a few of my thoughts on this subject.

The equation will vary depending upon the lifecycle of your business, your tax strategy and, to some extent, the profitability and cash flow situation.

Concerning depreciation, one should sum the cost of the equipment and facilities on the balance sheet. This number is then divided by seven or 10 to ascertain annual depreciation. Of course Section 179 and other depreciation strategies will alter the amount of depreciation reported on taxes.

In our dairy and creamery businesses, as a team we have established a goal of annual CAPEX of 5-8% of revenue or value of farm production, depending upon our profitability. This strategy allows for consistent upgrading of equipment and facilities to maintain the technology and efficiency edge. Frequently, producers will attempt to accomplish a total upgrade in one or two years; this can play havoc on financial leverage, liquidity and cash flow.

Do not forget your human capital. A new metric some are utilizing is spending 1% of revenue or value of farm production for training and development of management, owners and employees. This may include retainer fees paid to advisory boards. In today's information-filled industry, having a highly motivated, well-trained team is critical to success. Keep in mind that both capital and human assets will rust out, wear out or fade out if not proactively maintained and nourished.

 

Editor’s note: Dave Kohl, Corn & Soybean Digest trends editor, is an ag economist specializing in business management and ag finance. He recently retired from Virginia Tech, but continues to conduct applied research and travel extensively in the U.S. and Canada, teaching ag and banking seminars and speaking to producer and agribusiness groups. He can be reached at sullylab@vt.edu.

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