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Iron Man: Superhero or Financial Drain?

A question our clients commonly ask is: “What is the right machinery investment for my farm?” We see a wide range of investment in iron which can have an impact on cash flow and, more importantly, net income of the operation. In order to illustrate this point we will look at three farms: Ima Steeladict, E.Z. Dozit and Rusty Bult.

The scenarios

Ima Steeladict loves shiny paint, and is on the local dealers’ speed dial. He hates the thought of having to fix machinery and feels that timeliness of getting fieldwork done is crucial to his bottom line. Steeladict hates the idea of hiring custom workers and wants the ability to do everything himself in a timely manner. He does periodically do custom work for others as time permits.

E. Z. Dozit prides himself on having a functioning line of equipment that rarely leaves him stranded, but does demand regular maintenance and mechanic work. Dozit hires custom operators when needed and also does some custom work for others.

Rusty Bult is the king of arc welding and a master mechanic who uses the odd baling wire fix. Rusty’s newest tractor is the same vintage as a fine wine. Powerful Pierre was in power when it first rolled off the dealer’s lot.

Rusty is an excellent mechanic and isn’t scared to call in custom workers in the event of a major breakdown. Rusty doesn’t risk doing any custom work for others, mostly because he can’t bring his shop with him on the job.

Measuring your machinery investment

The mechanics of measuring the machinery investment in any given operation are relatively simple.

Start with the total equipment investment, make adjustments for custom work and other enterprises such as livestock and then divide the number by the total acres to arrive at a dollar per acre figure. Then compare this to gross revenue per acre.

We start by taking the total equipment investment number off the balance sheet at fair market value.

If a farmer uses equipment to do custom work, we remove the portion of the equipment investment that reflects the use of the machine for custom work. For example if your operation owns a high clearance sprayer worth $200,000 and you cover 20,000 acres a year, 10,000 of which are your own and 10,000 of which are custom work, we would reduce the equipment investment by 50 per cent or $100,000.

We deal with other enterprises such as a cattle operations by reducing the equipment figure by an amount that reflects the investment attributable to the livestock enterprise.

This final figure is divided by the number of acres to get a dollar per acre figure.

The benchmark

The number used to measure the investment is the equipment investment per acre as a percentage of the average gross revenue per acre. This is important to reflect differences between regions and special crops that require more equipment investment but will also yield more revenue per acre.

Our experience has indicated a range from 50 to 200 per cent. For example in a area with a average gross revenue of $400 per acre, the equipment investment ranges from $200 to $800 per acre.

There are risks and rewards at both end of the spectrum.

For Steeladict, with a machinery investment ratio of close to 200 per cent, the risk is depreciation. Steeladict’s production risk is greatly mitigated by his machinery investment. Fieldwork is done in a timely manner and production is always maximized for the environment.

In years of high production and prices this can be money well spent. The problem is that there is always depreciation, whether you use the machinery or not. In years when prices are low and production is poor the depreciation cost per bushel is very high. Depreciation is sometimes a hard cost for a business to recognize until the equipment needs to be replaced. Until you need to replace the equipment with a comparable unit, depreciation has no impact on cash flow.

For Dozit, with a machinery investment ratio of 100 per cent, the risk is a balance of depreciation repairs and maintenance and custom work. Dozit’s production risk is reasonable, given his machinery investment. The benefit Dozit sees is flexibility to reduce costs in years of poor production. For instance in a year when he has only a 20 bushel per acre crop, his old combine can handle all his acres and his cost to own that combine is low. In years of high production Dozie has the risk that of being unable to get custom operators whenthey’re needed.

For Bult, with a machinery investment ratio of 50 per cent, the production risk is extreme. In years of poor production Bult’s machinery costs are minimized. However in years with high production potential, Bult is not likely to realize that potential. His other risk is high repair and maintenance costs, which can have drastic impacts on cash flow and profitability.

In summary each of these three chaps are comfortable with their situation. The important part is they are conscious of the risks that their machinery invest ratios bring. They may choose differently in the future based on their goals, and the stage of their farming career. †

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