I get this question all the time as an agriculture business adviser with MNP: “Can I afford to buy …?”
Sometimes before I can answer, I will get a 10-point explanation as to why a new combine, tractor, drill or sprayer is needed. The producer seems to be looking for reassurance or approval that the purchase is a good idea. You can tell they really want it and so my opinion may not matter.
However, sometimes they are genuinely looking for advice to ensure that the business will benefit financially from the purchase.
The cost of machinery has escalated to a concerning level in the past 10 years.
Most major capital items that producers require are being quoted at more than $500,000 since the recent drop in the Canadian dollar to less than US80 cents. That means prices have almost doubled in a decade. As a result, machinery buying decisions have become a lot more important.
Machinery costs have become one of the most significant expenditures on a grain farm. Many farms expense as much or more annually on machinery than on fertilizer.
The first thing I normally ask is what is wrong with the existing machine. Is it outdated or too small, and how is that affecting the farm’s ability to maximize crop revenue?
Once we conclude that changes are needed, we can then start talking about affordability.
Knowing a farm’s cost of production can make a significant difference in helping decide whether to buy that new combine.
Farmers who know their costs know how the purchase will affect their bottom line.
Farmers should also break it down further to determine their machinery cost per acre. This might surprise some farmers once they have it calculated.
I calculate machinery cost per acre by using a reasonable estimate of annual amortization, which is the estimated amount of value lost each year as the machine is used up.
Farmers who buy a new combine for $500,000 that is worth $425,000 after one season have an amortization for that year of $75,000. If they farm 3,000 acres with that combine, their amortization per acre for that specific machine is $25 per acre.
Assume the same for the sprayer, tractor and drill and you can reach almost $100 per acre in a hurry.
An old combine that is worth $250,000 and is expected to drop in value to $210,000 in one year will have an amortization of $40,000 for the year. The cost per acre is $13.33 if the combine can do 3,000 acres, which is 50 percent less than the new machine. That is a big difference.
I think prairie grain farms should be aiming for $40 to $60 per acre for their amortization on all equipment, excluding the cost of bins and buildings.
This is a rather large range, but it depends on the location of the farm and the window of opportunity that is available to get the work done each year. A cost of $40 to $60 per acre is sustainable, given the volatile commodity prices we have seen and all the biological and weather risks faced every year.
Total cost of production on most grain farms has increased to more than $300 per acre and sometimes as much as $400 per acre.
One of the biggest culprits for this is rising machinery costs, and I advise all producers to calculate and monitor their costs of production.
A good business adviser can estimate the number at the crop planning stage, mid-year and then after harvest to provide the information that is required to make decisions on the appropriate level of machinery for the operation.
If farmers and their business advisers conclude the new combine is affordable, the next question is do they buy or lease. This will be discussed in a future column.
Stuart Person, CPA, CA, is a business adviser with MNP LLP.