November 4, 2019
Getting a Handle on Equipment Costs
By Brent Gloy
by Brent Gloy and David Widmar
With farm income remaining depressed, managers are keenly focused on ways to improve their efficiency and cost competitiveness. Examining their investment in farm equipment is undoubtedly one area that deserves attention. Farm equipment generates a significant portion of the costs associated with farming. In our experience, they are also one of the items that people have the most difficulty evaluating and managing.
Farm Machinery Expense
The investments associated with equipment are economically large, impact the farm for years, impact financial decisions, impact taxes, and influence the way in which the farm carries out its operations. In most cases, it is difficult to make wholesale changes in equipment in a short time frame. As such it makes sense to have a coordinated and thoughtful plan that will result in the best economic outcome for each farm. As we wrote a few years ago:
“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 the speed with which they can conduct planting, tillage, and harvesting operations. The result is a very wide range of potential equipment configurations that are observed on most farms. These trade-offs make evaluating the equipment investment on a farm a difficult task.”
To get a handle on the magnitude of costs facing farmers we examined USDA’s estimates of the cost of corn production. Summary data for the Heartland region of the U.S. are reported in Table 1. The largest expense associated with equipment investment is capital recovery. This is a charge designed to account for the depreciation of a farm’s machinery investment. In 2018 this was estimated at $121 per acre. Combined with repairs, these costs were $153 per acre. These expenses are significant, accounting for 41% of all farm overhead costs. The other major overhead expense, the opportunity cost of land was only slightly larger at $193 per acre.
Farm Machinery Cost Over Time
Like other expenses, the costs associated with machinery have grown significantly over time. Figure 1 shows the nominal expenses on farm machinery estimated by USDA over the last 10 years. The capital recovery charge has increased at an annual rate of 5.2% over that time. Most of the increase occurred from 2015 to 2016 when the charge was increased by 18%. The large increase in 2015 to 2016 reflects the fact that the base survey used to estimate the costs changed in 2016. Prior to that, the estimate reflected the equipment estimated in a 2010 survey. ERS explains this as follows:
“Estimates made in the survey year should be regarded as the most reliable because they reflect both prices and technologies used on the commodity. The reliability of estimates in non-survey years likely varies for each commodity by the degree of technical and structural change that has occurred since the last survey.”
Figure 1. Capital Recovery of Machinery Investment, Heartland Region, Corn Production 2008-2018.
As we can see the costs have increased substantially over time. Because they represent such a large portion of expenses, it is critical that they are evaluated carefully. However, measuring these costs is complicated. The biggest complicating factor is usually evaluating depreciation. Although the ability to accelerate depreciation for tax purposes is valuable, for large pieces of equipment economic depreciation and tax depreciation usually bear little resemblance to one another. Another factor that must also be considered are hidden costs associated with insurance and storage costs for equipment.
Wrapping it Up
So where does one start? For those interested in a short but helpful discussion of evaluating equipment costs, this resource from Iowa State is a good place to start. The typical advice is to begin with the depreciation, interest, repairs, taxes, and insurance or DIRTI costs. We also recommend that producers carefully evaluate any costs and revenues associated with custom hire when evaluating their equipment costs. The key is to measure and track these costs over time. It also makes sense to focus on the largest of these expenses, which is typically depreciation and repairs. While repairs are easier to track, depreciation will require more work and gathering data on the economic depreciation.
When evaluating these costs it is important to develop a capital expenditure plan for the next and subsequent years. What equipment will need to be replaced in the coming years? How will this impact the operation? How do the costs of owning and operating equipment compare to the costs of custom hire? Will the equipment complement chosen impact other factors, such as farm labor requirements? How will equipment purchases be financed, and how does that impact the overall financial condition of the farm? How do purchases impact taxes and how will cash flow be raised to make required principal payments on financed purchases?
All in all, choosing the equipment complement of the farm is one of the most important but most complicated decisions farmers will make. Because the costs are high, the implications for these decisions are substantial. Given the challenging times in agriculture, making wise equipment investment decisions can be the difference between profit and loss for years to come.