May 26, 2015
Equipment Investment: How Much is Enough?
By Brent Gloy
The rapid descent of crop prices and resulting margin squeeze have forced farmers to carefully evaluate their financial structure and look for ways to reduce their cost of production. Because prices for inputs such as fertilizer and seed have been slow to adjust, much of the attention has turned to fixed costs such as land rents and equipment costs. These are typically the largest categories of fixed costs on most farms. While we have looked at costs associated with farmland extensively, equipment costs are often very large on many farms and deserving of attention. There is likely great variation in equipment investment and costs across most farms.
There is ample evidence that these costs have increased substantially in recent years. Gary Schnitkey highlighted that total power costs on Illinois farms roughly doubled between 2006 and 2012 and pointed out that increases in depreciation account for the lion’s share of the growth. We examined the increases in tractor and combine ownership and equipment ownership costs.
One thing is certain, if you visit many farms, you will observe a wide range of equipment investment decisions being implemented. For instance, farmers can buy new or older equipment thereby likely trading off repair expenses and perhaps speed and efficiency for investment costs. Farmers can outsource many field operations or choose to conduct these themselves. Farmers have different amounts and sizes of equipment thereby likely trading off investment cost and the speed with which they can conduct planting, tillage, and harvesting operations.
The result is a very wide range of potential equipment configurations. These trade-offs make evaluating the equipment investment on a farm a difficult task.
Equipment Costs: How High?
So where should one start when evaluating the equipment investment profile of a given farm? One possible place to begin is to examine various University crop budget estimates of equipment costs. Machinery costs are consistently the second largest fixed cost category (land is the largest). Estimates of the exact level of these costs vary considerably from budget to budget. This is not surprising given the very wide range of options that one might use to conduct the field operations associated with equipment investment and the different geographies under which production takes place. For example, in a higher rainfall area you might expect farmers to have more or larger equipment in order to guard against shortened planting and harvesting windows.
So what do various crop budgets suggest are reasonable estimates of machinery costs? Table 1 shows a summary from various corn crop budgets from Corn Belt. The budgets are all formatted slightly differently so we included the “total power costs” and the depreciation or capital recovery estimates for equipment. The total power costs would include fuel, repairs, and any custom hire expense. For instance, hauling expenses were included in total power costs when summarizing the Purdue crop budget. The USDA cost of corn cost of production estimate for the Heartland region is shown in the last line of the table.
Most of the estimates allow for differences depending on the assumed farm size and crop rotation. This reflects different equipment needs as well as the potential to reduce per acre equipment costs with farm size. The Purdue budgets are slightly higher than those in Illinois and Iowa, with much of the difference apparently in the machinery ownership line. The depreciation expenses range from $60 per acre to over $100 per acre. USDA estimates that corn farmers in this region face capital recovery costs on equipment of nearly $100 per acre.
The first step ought to be to take a look at depreciation expenses. Values exceeding these levels are certainly worth investigation. It is likely that these costs will need to come down unless prices recover. However, the machinery cost estimates in these budgets should be used as only a starting point in the evaluation of equipment cost structure on any given farm. Just because costs are higher or lower, does not necessarily mean that the situation is favorable. It will be necessary to dig further into the particular situation to determine if costs are abnormally high or low. However, we think that it likely bears investigation on many operations and the numbers in the chart above are probably a good place to begin your assessment.
One of the key drivers of equipment costs is machinery investment. Take a look at this great chart (Figure1 toward the end of the article) developed by Michael Langemeier and Gregg Ibendahl in a 2014 Journal of the American Society of Farm Managers and Rural Appraisers article. It shows the dramatic differences in machinery investment per acre across Eastern Kansas farms participating in the Kansas Farm Management Association.
As one would expect, the range was really wide for farms with less than 1,000 acres, but even among the larger farms the differences were substantial. Many were operating with an investment between $100 and $200 an acre in equipment, while others had investment exceeding $400 per acre and some much higher than that.
Wrapping it Up
Langemeier and Ibendahl rightly point out that machinery investment per acre should be used in combination with other benchmarks when evaluating profitability and caution against just assuming that farms with high machinery investment levels are unprofitable and that those with low investment are profitable. This is good advice. In some cases it might even be appropriate to invest in improved equipment, and in others nothing could be further from the truth.
The answer to how much equipment is enough will likely vary from farm to farm and situation to situation. However, that shouldn’t serve as an excuse to examine these investments and costs carefully.
Photo by Johnny Klemme