December 1, 2022
“How should I approach equipment purchases given higher interest rates and supply issues? Should I bite the bullet and take on debt or run the old, outdated equipment? Do you have any rules of thumb?” This was an intriguing question from a producer at a recent conference. This question also prompted an end of season hayfield discussion on our farm.
An assessment of the machinery and equipment inventory needs to be conducted annually. An old rule of thumb is that whatever the value of your total machinery inventory, budget 10 to 15 percent of that value annually for replacements. For example, if the equipment inventory is worth $1 million dollars, then it would require $150,000 of annual capital expenditures either paid for by cash, debt financing, or a lease.
Evaluate your potential purchases as green, yellow, and red priority. Green light indicates a high priority need. Yellow light is in between a need and a want. Red light is classified as a want. For example, in our business the upgrade of a mower conditioner is a green light or a need. On the other hand, a new tractor is a yellow or red light depending on financial liquidity and cash flow for 2023 and 2024.
Examine repairs and parts expenses of older and outdated equipment. Will repairs and maintenance exceed the normalized depreciation expense on new, upgraded equipment? The next big question to consider is can you work on and repair the new equipment? Older equipment may lack the “bells and whistles” of the new paint, but it is often simpler to repair. Does the operation have someone that can repair both the new and old equipment. Our son is a good mechanic and serves in this role on our farm. Next, will you experience any downtime by getting rid of or upgrading the older equipment? The older equipment may serve as a backup or “plan B” should the newer equipment become an issue. The 2955 or the old 4020 John Deere both have a vital place in our operation where timeliness has become a big issue due to our off-farm commitments.
Finally, I cringe while saying this, what are the tax implications? Oftentimes, taxes are the number one consideration, particularly over the next couple of months. However, income taxes have to be balanced with working capital, operating needs, and cash flow. This will become even more critical in the economic scenarios on the horizon.
Get ready for sticker shock in capital expenditure budgets. The increased cost of new machinery and equipment will ripple through your cost of production and breakeven adjustments. Machinery cost budgets are getting blown out of the water by inflating costs and supply chain challenges.
Related:5 ways to manage 2023 margins
Recently, I conducted a program with the FINPACK team at the University of Minnesota at the American Bankers Association’s Agricultural Bankers Conference. In their database, the top 20 percent of profitable producers had $100 to $150 lower machinery cost per acre when compared to the bottom 20 percent of producers.
Source: David Kohl, who is solely responsible for the information provided and is wholly owned by the source. Informa Business Media and all its subsidiaries are not responsible for any of the content contained in this information asset.
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