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Buy Time Or Trade?

Dr. Wendell Bowers packs rooms by talking about buying machinery. This author and retired professor of agricultural engineering, Oklahoma State University, says the biggest mistake farmers can make is to trade too early. On the other hand, keeping a machine too long can increase cost per acre due to downtime, obsolescence or lack of capacity, he says.

If he can accomplish one goal, it's to get farmers to think about the costs involved in owning equipment. "With the high cost of equipment, you can't go by the shiny paint, sticker price or what your neighbor is doing," he says. "It's better to make your machinery investment decisions based on a projected net unit cost per acre."

Recently Bowers spoke to 150 farmers at the Ag Tech conference in Des Moines, IA, sponsored by Farm Industry News. At the meeting, he handed out two 3-x5-in. index cards and gave the farmers two assignments: identify anything in the presentation that would help you in your business, and rate the value of the net unit cost method as it would apply to your business.

The topic at the top of the farmers' list? Leasing vs. owning a 225-hp tractor. "Almost always you can beat the leased cost by owning a machine at least four years," Bowers says. That's because your cost per acre drops with each year of ownership. But you could have limited finances or other special circumstances in which leasing would be the better option.

In response to the second topic, 80% of farmers said the unit cost method would be very valuable to their business. How far are farmers in adopting this method? "Very early," Bowers says. The fact is, many farmers today make machinery purchases solely on instinct. That can be dangerous considering machinery is a farmer's single biggest input cost, other than land. One wrong decision can have a staggering effect on a farmer's bottom line.

Method to the madness. The reason instinct drives machinery buying is that the decision is so complicated, explains agricultural economist Dr. Terry Kastens, Kansas State University. It involves income tax brackets, producer price indexes, depreciation (the amount of market value lost each year due to wear and obsolescence) and other costs farmers must factor in.

"So, what farmers often do is make the decision intuitively from viewing their neighbors and personal experience over the years," Kastens says. What he hopes to do is mix in a little math so farmers can make the decision more objectively.

The good news is there are books and software that can help you do that. Some are available free of charge through your local extension office. Kastens, for example, has written a booklet titled Farm Machinery Operation Cost Calculations. Bowers has authored a book and companion software titled Machinery Replacement Strategies. The guides walk you through formulas to calculate the costs of owning and operating farm machinery. Costs include the "DIRTI 5" (Depreciation, Interest, Repair costs, Taxes and Insurance), timeliness cost (the crop loss incurred from an operation not being performed on time), machinery list price, hours used, fuel and lubricant costs, storage and labor costs.

Once you've added up the costs, divide them by the number of acres you farm to arrive at a net unit cost per acre. If you're looking to buy, do these calculations twice: first to figure the costs to repair and keep your old machine, and second to figure costs for a new machine.

Timing your trade-in. Bowers recommends you project a machine's unit cost per acre for as many years as you expect to own it, stretching it as far as eight years out. That's because most farmers are on an eight-year tax depreciation schedule, called the 150% Modified Accelerators Cost Recovery System (MACRS).

Take your first critical look at costs after the fourth year, he says. By then you will have written off the majority (57%) of tax deductions allowable under the schedule. "I'm not saying trade every four years," Bowers says. "But your tax write-off will be less after the first four years, so you need to evaluate at that time whether it is your best cost advantage to continue owning it."

The next critical time to evaluate equipment cost is at five years. By that time, it's likely you have paid off a loan, which, in turn, affects cost per acre. Take your third critical look at eight years, when you will have used all of your allowable tax deduction. You'll also need to look closely at downtime and repair costs.

Bowers says these timeframes apply mainly to major pieces of equipment with high annual use, such as tractors, combines, planters, forage harvesters and large balers. If you farm around 1,500 to 2,000 acres, your equipment has high annual use. The timeframes won't apply to everyone, but they are a good rule of thumb.

Weighing the costs. Projecting unit costs per acre will help reveal which option - repairing and keeping your old machine or trading for new - is better. To illustrate, Bowers shows how ownership costs change for a $190,000 combine over 10 years at three acreage sizes (see line chart). Look at the line that corresponds most closely to your farm size to see how the costs might play out for you. The biggest cost break occurs at four years on all three farm sizes. The next break comes at six years, and then costs start to level.

"If I were the 2,000-acre farmer, six years is the longest I'd keep the combine because even though costs continue to drop, the reliability and timeliness factors may begin to outweigh the savings," Bowers says. On the other two farms, he would trade no later than eight years. To extend life beyond four years, you need to follow a good preventive maintenance and preseason service program to maintain reliability.

That's one example of how costs change. In general, when you own a machine, you have to consider it will continue to depreciate; that is, it will be worth less every year and every hour of use, explains Dr. Jess Lowenberg-DeBoer, agricultural economist, Purdue University. That's a cost, he says. Your older machine also will likely have higher repair costs than a new one. Those have to be weighed against the costs that would be incurred in doing the same job with new equipment, he says.

When you buy a new machine, two costs will go up: depreciation and interest, explains Kansas State's Kastens. That's because its value will be higher than the machine you traded in. You need to weigh those costs against the reduction in repairs likely with a new machine, the increased timeliness due to fewer breakdowns, and increased capacity if the machine you buy is larger. So what's the bottom line? Kastens explains: "If the potential rise in depreciation and interest costs with a new machine is less than the potential rise in repairs and timeliness costs with the older machine, then you'd be better off trading."

Tricks of the trade. There are things you can do to tip the scale when projecting cost calculations. For instance, if you want to minimize the costs of your old machine, you can schedule a preventive maintenance inspection every 1,000 hours for a tractor and every 600 hours for combines, advises Jim Beal, co-owner of Taking Care of Business, a dealer consulting service.

Beal says preventive inspections at these intervals can significantly reduce your repair costs, which would otherwise run, on average, $2,400 for out-of-warranty tractors and $3,600 for out-of-warranty combines in between inspections. "A dollar of preventive maintenance is the equivalent of $2 of repair maintenance," Beal says. The inspection performed by your dealer costs around $300 and will reveal which parts need to be replaced and which ones will go another season. If your equipment is well maintained, you'll also have fewer breakdowns. That, in turn, leads to lower timeliness costs. Downtime is most expensive while planting corn because you have limited days to get the crop in according to Lowenberg-DeBoer. "Every hour in downtime during planting may cost easily from $300 to $500 in lost yields," he says.

On the flip side, you can help justify the cost of a new purchase by leveraging tax breaks, dealer discounts and deferred interest. Another way is by consolidating. For example, you could trade two smaller tractors for one bigger and lower your labor and net cost of use by putting more hours on it, Bowers says. That requires you buy enough horsepower to till and plant in a timely fashion.

Avoid buyer's remorse. Bowers' book helps you estimate timeliness costs, since they need to be projected in your comparative analysis. At his workshop in Des Moines, this was the second biggest topic of interest to farmers. "Apparently, many of them had not tied any figures to what they had always worried about, and that is getting things done on time," he says.

You can take a huge bite out of timeliness costs from the start when it comes time to trade. How? By making sure you buy enough capacity to finish the operation within the optimum window of time. The window is typically 10 calendar days for planting and 21 days for harvest. The windows vary by region, as Purdue's Lowenberg-DeBoer learned firsthand. He grew up in western Iowa where he says the window for planting and harvesting is much wider than it is in the eastern Corn Belt. "So when I got to Indiana, I thought these farmers were enormously overequipped because the equipment they had on, say, a 600-acre farm would be good for double that size in western Iowa."

But, he discovered, because of the higher rainfall and clay content in the soils, farmers in Indiana need bigger equipment to finish on time. "So, what is overequipped in one place is not overequipped in another." He says the size of machinery you select also depends on weather conditions, soils and your risk attitude. "How much are you willing to push that envelope and take the risk that in a particularly wet year you're not going to have the capacity needed to get done?" To be safe, Bowers recommends you overcompensate by buying equipment up to 25% larger than what you think you need. "The worst thing you can do is buy or trade for a new combine or planter and find out two or three years later that you should have gotten one bigger," Bowers says. "Now that's expensive. It forces you to trade much too early."

For a free copy of Kastens' Farm Machinery Operation Cost Calculations, contact the Department of Agricultural Economics-Extension, Dept. FIN, 304 F Waters Hall, Kansas State University, Manhattan, KS 66506, 785/532-5866 or circle 249.

To order Bowers' book and software, Machinery Replacement Strategies, contact John Deere Publishing, Dept. FIN, John Deere Rd., Moline, IL 61265-8098, 800/522-7448 or circle 250.

For information on preventive maintenance, contact Taking Care of Business, Dept. FIN, Box 38, Allenspark, CO 80510, 303/747-0447 or circle 251.

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