In this series of articles, I looked at various profit robbers on the farm and how to address them. In Part 1, I examined the biggest offender — machinery depreciation — and how sneaky it is, since it’s a hidden cost that doesn’t affect your cash flow. To minimize this cost, I suggested you consider buying reliable used machinery instead of new. If you are determined to buy new, hold the piece for a longer period of time to minimize depreciation costs over the lifetime of the item.
Sell machinery you’re not using, watch out for too much farm diversification and make sure your operation is generating enough profit to afford the “toys.”
In Part 2, I examined higher machinery payments on new equipment and how they are a profit robber. In this case, I’m referring to the interest portion of the payment. The principal portion of the payment builds equity, however (unfortunately), depreciation is greater than the equity you are building, so you are in a net loss position. If we take the first two profit robbers together (depreciation and interest), they are a double whammy to your profitability.
Now, let’s look at some other possible profit robbers that may be lurking on your farm. Ask yourself, “Do I really need all the machinery in my yard and how often do I use some of the pieces?”
I’ve visited farms and seen machinery that looked like it hadn’t been used for quite a while (or even a long time). I am usually told, “We don’t use it anymore, but it’s paid for, so it doesn’t cost us anything.” Then, when I talk about depreciation, they reply, “Aw, it’s not that much.” I suggest they sell these pieces and get some money for them. That will be much better than keeping them until they’re not worth anything.
Small- to medium-sized farms are at a real disadvantage when it comes to buying new machinery for a couple of reasons. First, new machinery is usually sized for large amounts of acres, so it’s too large and expensive for these farms. Second, as equipment is becoming more computerized, it’s difficult, if not impossible, for farmers to fix it themselves. What can farmers in these situations do? The following are some suggestions:
- Renting equipment for short-term jobs is a much better alternative to owning it (if possible).
- Share equipment with close friends and neighbours. While this can create problems, for those people who can make it work, it’s a great cost reducer.
- Hire a custom operator, which is already popular for spraying crops and is expanding to other areas of farming as well.
Another example of a depreciation robber on small- to medium-mixed farms is too much diversification. These farms usually have specialized equipment for every enterprise. For crops they will have one or more tractors, harrows, a seeder, sprayer, swather, combine, trucks and maybe even a grain bagger and unbagger.
For forages, they will have a haybine, rake, baler and a tractor with a front-end loader. For cattle, a grinder-mixer, bale busters and other specialized equipment. These farms have lots of items, all of which are depreciating. In addition, most items will be sitting idle for most of the year and not generating any profit for the farm.
I suggest farmers in this situation consider specializing in one or two enterprises and sell the surplus machinery. That makes sense from a depreciation reduction standpoint as well as a business management standpoint. It’s much easier to be really good at one or two enterprises rather than four.
Pay cash for toys or scale down expectations
There is a popular adage that goes like this, “The main difference between men and boys is the price of their toys.” I think we can also include women and girls in this, but unfortunately that doesn’t rhyme.
Some years ago, I heard a farm business consultant talk about farms that were experiencing financial challenges and how to address them. One comment from that time really stuck in my mind. He said when he drove onto the yard at one of these farms and could see a motorhome, boat, ATVs, one or more fancy half-ton (or even three-quarter- or one-ton) trucks and other “toys,” he knew pretty well what one of the major causes for the situation was. Toys are fun to have and enjoy, but only if your farm is generating enough profit so you can readily afford them.
Another situation from my own experience went like this. As part of my farm financial analysis, I use a program called ABA or Agricultural Business Analyzer. The farmer was away, so I was working with his wife entering their loan details. We came to one item, a brand new fifth-wheel holiday trailer/toy hauler (triple axle), which was the largest I had ever seen.
She said they had just bought it and she had to get the loan agreement. They owed $78,000 and the payments were $640 per month at 7.75 per cent interest, but she couldn’t find the term (length) of the loan. I entered the available information into ABA and it calculated it would take 20 years to retire (pay out) the loan. She was totally flabbergasted as she thought there would be a maximum of 10 years.
When the farmer came home he confirmed he knew the term was 20 years and he was fine with that. I just checked the price of a 20-year-old fifth-wheel trailer and it’s about $20,000. Depreciation over 20 years, in this case, is about $60,000. They would have had to make a total of $153,600 in loan payments over that time, which is close to double the original purchase price.
Again, toys are nice to have but only if your farm is generating enough profit to pay for them. For items like this, saving your farm profits for a few years and paying cash saves a lot of interest costs. Another alternative is scaling down your expectations and buying used as I suggested in the first article in this series.