The Rolling Equipment Problem

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SW Financial Literacy

The Rolling Equipment Problem

Why are margins negative? What can we do to make this work?

Inflation has been a huge problem for the ag industry. We see the price of everything moving higher. Everything that is except for the price of the commodity we are selling. Fertilizer is up big. Chemicals require us to go genetic and aren’t as effective as resistance grows. Seed is raising yield, but we pay more for those bags. Speaking of bags, groceries costs way more, along with the vehicle you own to drive them home (if you aren’t paying for a delivery service). Let’s not forget the taxes, cost per hour to repair equipment, health insurance, etc.

Yes. Everything is higher.

And yet here we are, staring at the same $4/bu corn while those $4.00 don’t go nearly as far with the inflation that has occurred. (Do you get now why inflation is scary and interest rates needed to move higher?) Yes, we are growing higher yields to increase profit, but that obviously isn’t enough.

With all these growing expenses, what can we control? Where do we begin?

How about seed? The price here can vary by the traits you are purchasing. Some of the traits are needed when you are susceptible to drought or fighting disease pressure. The other place it can differ wildly is by company. Yes, there are programs and discounts if you buy all your seed from the same provider, but to save $60k next year and probably raise the same number of bushels, it might be worth exploring (although you almost certainly already paid for your seed with early discounts).

Chemical and fertilizer? I lumped them together here because it seems prices are more controlled, or at least consistent, by region. You can look to change your N application or go the generic route. I also do encourage checking with another supplier, but you may not find much cost savings here.

What do we do with equipment? This is where I want to spend the most time, because it is a massive, looming problem. Just like the inflation from your other resources, the expense has risen significantly over the past 15 years. Unlike seed, chemical, fertilizer, and most other inputs, you don’t have to have this expense every year. If you buy a tractor and pay the debt off, you don’t need to be making that payment any more. This creates improved margins for your cash flow. (Yes, I know repairs will eventually be higher. I’ll get to that. Keep reading.)

First, I want to highlight leased equipment. Since the repair bills are covered for you, this is the easiest example to isolate. Let’s say you taking out a rolling 3-year lease for your biggest 4wd tractor:

7 years ago you took out a 3-year lease for an 8275R tractor which cost you $40k/yr. Great! The lease expires and you trade it in. Now you have an 8375R tractor which cost you $50k/yr. Not fun but you will take it. The lease expires and you trade it in. Time to renew for now an 8R 240 which cost you $65k/yr.

Ouch! Do you see the rolling equipment problem? This tractor is not generating any additional income for you and is costing your $25k more per year (and you have no interest in completing the buyout because the equity is upside-down on these right now).

Let’s look at owned tractors where the same situation plays out. You buy the tractor 7 years ago for $250k, take out a 5-year loan paying $60k/yr (loan payments on equipment are higher than leases because of the residual buyout not being factored into payments for the lease), and after 3 years decide to trade up. The new tractor now cost $350k, you get $150k for trade-in value, and you paid down $150k on the old machine, so your new 5-year loan is against $300,000 ($70k/yr in payments).

Finally, we trade 1 more time into the 8R 240. This tractor cost $500,000, you get $225,000 for your trade-in and have $120k debt against the new machine. Your new 5-year loan is against $395,000 with payments of $89,000/yr.

This is the equipment snowball I am seeing, and we can’t keep this up. If you are use to rolling the combine every 3 years, planter every 5 years, and tractor every 7 years, you are falling behind. We can’t afford to make the payments on this new iron any more. It may be time for a new plan.

So that’s the next problem. Repairs are through the roof! No-one can afford to make them. Not when a service call costs $215/hr before you even pay for the new wires and overpriced replacement iron. We can’t afford the new equipment payments (or leases) and we can afford to fix rundown equipment.

Here is what I propose. Hang onto the equipment or extend your replacement cycle by 1-2 years. If you roll the combine every 3 years, try 5 years. If the planter goes 5 years, try 8 years. All equipment needs repairs and breakdowns. I see repair costs run high on old equipment, but I also see it run high on new equipment.

If you don’t know how to fix your equipment and don’t have your own mechanic, seek one out. Some operations make sure their hired help on the farm is a mechanic, that way they can save on the repair bills and do better preventative maintenance. Yes, I know there some things the ‘dealership’ can only work on. Yes, I am proposing changing your help, or maybe paying a mechanic more than what you are currently paying our farm help. You can also split this expense with others. If another farm does all their own equipment repair work because they have a mechanic, ask if you can hire them out for a week or two. This would have two-fold benefit. You are keeping your repair bill down while easing their payroll for a week or two during their down time.

I’m not saying this is a perfect model or one that will work for you, but consider it.

Do you do something different that works for your operation? I would love to hear it! Send me an email and we can start a conversation: grant@farm640.com

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Grant