Now that summer fieldwork is pretty much wrapped up, preparing for harvest will be the next equipment challenge on our minds. Keeping some notes while you/employees are operating the equipment in season can help expose bottlenecks, mismatched equipment and needed replacements or updates.
These equipment issues can easily be forgotten within days if not recorded, as other priorities quickly consume thoughts and planning. Sometimes on paper “lowering expenses” by limiting updates or minimizing repair costs may not be the best option. The quality of these decisions become apparent when equipment hits the field. Additionally, running the fleet too long and not staying current on some of the larger pieces along the way can come with a hidden cost.
Choosing the best time to update equipment and managing costs at the same time can create some heartburn. As you manage through these capital-intensive decisions, there are three major areas of consideration which include an accounting perspective, replacement scheduling and market value conditions.
Accounting: Your primary ownership expenses should include principal and interest payments, repairs and depreciation. Additional equipment operating expenses such as fuel, oil, insurance, storage and other minor expenses should be included in the cost analysis as well.
Dialing in on these specific costs of equipment ownership will give you a current cash cost of your equipment. Furthermore, this will help you know an accurate and current cash out of pocket expense. While this method may be the most accurate in “true cost analysis,” it falls short on measuring cost and market value changes over time.
Replacement Scheduling: There are three key factors to effective replacement scheduling: available capital, prioritization and a comprehensive plan. First, available capital is your driving force. Everyone has a finite amount of cash available for capital improvements. Determine your number and stick to it.
Prioritization includes identifying the pieces of equipment that need to be replaced first, second and third. You may run out of cash before all the priorities are met in a given year and the next piece in line then must move up in first place for the following year.
The third factor is to make sure that everybody in your operation has a clear understanding of the short and long-term goals for your equipment. Rightsizing tractors, tillage, planting, sprayers, and harvesting equipment with more than one or two years in mind; while at the same time continually replacing something each year.
Market Value: To understand your actual cost of the equipment ownership over time is to understand the annual influence of depreciation and inflationary factors. When you purchase a machine and use it for one year, there is a market value depreciation cost.
Additionally, there is an inflationary cost assuming you will replace that equipment at some point in the future. The inflationary cost is not an exact science, however if an inflationary cost is not used as part of your cost of production you could have a major shortfall of cash when it’s time for the replacement.
Moreover, not factoring in inflationary costs for your equipment could lure you into marketing your commodities at too low of a price and making it that much more difficult to be current with equipment replacements over time. This is not to say marketing shouldn’t start until we’ve covered all “current and expected” expenses, but it so that we recognize when opportunities present themselves above those levels that we are aggressive and disciplined marketers knowing that we are covering current and future costs.
The definition of inflation is a general increase in prices and fall in the purchasing value of money. Additional inflationary factors include an increasing interest rate, an increase in the cost of goods and services (example: steel prices increasing 12%) or newer and better technology.
These and other inflationary factors cumulatively create a hidden cost that will show up when it’s time to replace or update into a newer model of machine. A basic example, a machine on year one may cost $100,000. Five years later that same “New and Improved” machine could cost $150,000. In this example basic accounting would miss the fact that the annual cost of ownership should include an additional $10,000 per year to cover inflation expense.
Equipment replacement is tricky business, so be sure to arm yourself with quality information. Current accounting for actual cost, a strategic written replacement plan, and cost outlook estimates that include inflationary cost estimates.