Farm Business Management Fact Sheet
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FARM BUSINESS FACT SHEET INVESTMENT IN HARVEST MACHINERY September 2017 Determining the optimum level of investment in harvest machinery Key points n It is critical to understand the policy that underpins the decision-making process when considering purchasing machinery SUMMARY of farm income. High performance farm n Understanding the total cost of Harvest machinery is an essential businesses can maintain a ratio of 0.8:1 or ownership in $/ha or $/hr is crucial for part of any grain-growing business lower without compromising timeliness. effective machinery decision-making. and requires significant investment of Despite this, many farm businesses have This helps when making decisions capital. Understanding the total cost of a machinery investment ratio of 1.2:1 or about the use of contractors versus ownership, developing policy around higher. ownership decision-making and ultimately how to Take a typical example of about n When the cost of owning a new leverage the investment is a crucial part $1 million of income for every $1 million machine is cheaper in $/ha than of machinery ownership. This is also a of machinery, the difference between the existing machine then it should key driver of farm performance. running a 0.8:1 ratio and a 1.2:1 ratio ideally be changed over represents the investment of an additional n Understand the level of machinery BACKGROUND $400,000 in capital. In relative terms, investment across the business and Machinery can be a contentious subject. when considering the annual costs of identify ways to get more from your Too little or too old can lead to higher depreciation (10 per cent) and finance (5 investment repairs and maintenance bills and cause per cent), this translates into about $60,000 timeliness issues. Too much machinery can of additional cost per year. The top 20 per see finance costs and overhead structures cent most-profitable grain growers have Matching machinery assets to quickly become disproportionate. A rule consistently demonstrated that they can requirements involves developing business of thumb for grain growers is an average essentially retain this as additional net policy, understanding the true total cost of machinery investment to income ratio of profit by maintaining a 0.8:1 machinery ownership and being able to leverage the 1:1 or $1 of machinery assets to every $1 investment to income ratio. investment. P Level 4 | 4 National Circuit, Barton ACT 2600 | PO Box 5367, Kingston ACT 2604 grdc.com.au 1 T +61 2 6166 4500 F +61 2 6166 4599 E [email protected] HARVEST MACHINERY INVESTMENT n brand of machinery (preference, serviceability etc.); How to calculate your n budget, level of initial investment or capital changeover cost; and machinery investment ratio n personal goals. Example For a detailed guide on developing a machinery policy and Total market value of plant and equipment (A) replacement schedule see GRDC Business Management Fact (4-year average) $800,000 Sheet ‘Put a policy around machinery purchases’ (www.grdc. Total gross farm income (B) com.au/GRDC-FS-PolicyAroundMachineryPurchases) (4-year average) $1,000,000 Machinery investment: income ratio (A/B) 0.8:1 TABLE 1 Total cost of harvester ownership. AM I OVER-CAPITALISED? Capital cost Machinery investment to income ratio Purchase price (A) $850,000 The best way to get a quick gauge on your investment Sale price (B) $350,000 in machinery is a simple machinery investment to farm Life of machine (C) 7 Years income ratio. Place a market value on total plant and Annual depreciation (A – B) ÷ C = (D) $71,429 equipment (recent clearing sale results or insurance Interest cost values are a good start) and divide that by the total gross income of the farm business. Interest rate (E) 4% This ratio should be averaged over at least four years Annual interest cost ((A + B) ÷ 2) x E = (F) $24,000 to get an average across farm income and machinery Overhead costs assets. Ideally the result should be a ratio of 1:1 or $1 of Annual insurance cost (G) $3400 machinery invested to every $1 of income. Getting this as Annual registration cost (H) $300 low as 0.8:1 is possible and should be aimed for. Value of shedding (I) $250,000 Percentage of the shed used by the machine (J) 20% MACHINERY INVESTMENT POLICY Annual shedding cost (I * J) ÷ 10 = (K) $5000 Effective investment in harvest machinery comes from well- Repairs, maintenance and fuel costs developed policy. The machinery decision-making process Repairs (L) $30,000 should start with a discussion about policy. Many growers will Oil and grease (M) $3000 intuitively have some sort of policy on machinery investment, although it may not be communicated or written down. Total cost per year (sum of D, F, G, H, K, L, M) = (N) $137,129 When talking about farm machinery, growers all have a very different approach or ‘policy’. For example: UNDERSTANDING THE TOTAL COST OF OWNERSHIP n Grower 1 – Buys new harvesters and changes over every Being able to identify the total cost of ownership involves a 1200 hours rigorous analysis of the costs associated with a piece of farm n Grower 2 – Looks for good second-hand harvesters and machinery. It also involves being able to quantify risks such as may take them from 1200 hours out to 2500 hours harvest timeliness, grain quality and/or yield penalties. n Grower 3 – Buys second-hand harvesters and runs them Determining the total cost of ownership of any given until they drop. machine involves calculating the following (Table 1): There is no right or wrong approach and each policy n Annual depreciation cost will be different. The decision-making should reflect each Depreciation generally accounts for wear and tear and businesses approach to risk, the capacity to undertake repairs obsolescence on an annual basis for a machine. A straight line and maintenance, and the appetite or financial capacity for depreciation method is sufficient for calculating depreciation different levels of initial investment. for management decision-making purposes. Despite this intuitive thinking, a documented policy that is n Interest cost openly communicated within the business allows for greater This is the interest on the capital relating to the machinery feedback, depth of thinking and commitment to the overall purchase amount that could be invested elsewhere and business strategy when it comes to investing in machinery. Some accounts for the opportunity cost associated with the investment. points to consider when developing machinery policy include: n Insurance and registration costs n upgrade frequency (number of hours, hectares or kilometres); These are overhead costs, which will vary according to the size n functionality; of the machine. n strategic business need; n Annual repairs, maintenance and fuel costs? n proactive management of risk; These are variable costs determined by the annual usage of n occupational health and safety; the machine. It is important to get a realistic idea of these costs n personal productivity; before purchases are made. n employee productivity; n Labour costs n capacity to manage breakdowns; Consider and cost permanent labour or any casual labour for n efficiency objectives; peak periods that may be required to operate and maintain n ease of use and employee understanding; machinery. 2 grdc.com.au HARVEST MACHINERY INVESTMENT ASSESSING AND QUANTIFYING RISK, PENALTY AND In the example worked through in Table 3 the ‘break even TIMELINESS COSTS area’ required to economically justify the ownership of the Typical risks that need to be considered when assessing header is 2098ha. The actual program is across 2500ha machinery ownership include: hence the total cost of ownership is in balance. n Grain delivery risk – misclassifications of grain if delivered in a “dump and run” manner by a contract carrier is a WHEN SHOULD I USE A CONTRACTOR FOR HARVESTING? significant risk. Once you have calculated the total cost of ownership, the final n Compliance / obsolescence risk – parts are no longer result can be compared to a contractor rate. Generally, you available should consider the use of a contractor if the cost of ownership n Timeliness risk – delays in sowing, spraying and harvesting is higher than that of the contract rate being compared against. can all have significant impacts on future income. If you Remember to take into account reliability, access to contractors lose trust in a machine, it is time to upgrade as timeliness is and timeliness risk. Contractors can also be a cost-effective option everything. A maintenance schedule contributes greatly to for high volume harvests, as an alternative to buying an additional operational timeliness. header. Alternatively, you could consider machinery syndication n Workplace health and safety risk – ensuring employees (a part-share in a machine to spread the cost) but this relies on are safe and productive is essential. The financial penalties strong relationships with other involved parties. associated with non-compliance are huge. Being able to quantify risk is important but being able to measure its frequency is the key. For example, the impact of a wet harvest may cause $X reduction in grain quality and take X number of extra days to complete, so the financial risk would be considered ‘high’. However, if the likely frequency is for example 1 in 5 years, the rational justification of extra investment in machinery may not provide a sufficient return. Using tools such as the CliMate app (https://climateapp.net.au) TABLE 2 Effect on work rate with differing field efficiencies. you can develop some rigorous justification and planning around Speed Width Efficiency Work rate (ha/h) weather risks such as a wet harvest. A good option can be to 12km/hr 12m 80% 11.52 plan contingencies should the wet harvest occur, without over- 12km/hr 12m 70% 10.08 extending in terms of machinery investment ‘just in case’.