analyzing machinery costs - css.wsu.edu
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Analyzing machinery costs
METHODS FOR CALCULATING AND COMPARING COSTS
KATE PAINTER, UNIVERSITY OF IDAHO
•Machinery investment is the 2nd largest investment after real estate•Annual machinery costs are a large part of a farm’s total annual costs
•Ownership costs: depreciation, interest, taxes, insurance, housing, lease payments•Operating costs: repairs, fuel, lubrications, labor, custom hire, rental payments
Impacts of machinery costs
Estimating machinery costs•Infrequent but large cash outlays
• $100,000+ for a tractor, $300,000+ for a combine, $200,000 for a self-propelled sprayer
•Noncash costs, such as depreciation, can be large as well
•Ownership (fixed or overhead) costs: • Cannot be avoided except by selling the machinery• Depreciation: noncash expense that reflects the loss in value due to age,
wear, and obsolescence
Calculating economic depreciation•Average annual depreciation:
• (cost – salvage value)/years of life
•Not the same as depreciation for tax purposes, which will follow IRS rules
•Economic depreciation should reflect the actual decline in value
Fixed costs of machinery: interest•Investing in machinery ties up capital that could be used for something else
•There is an opportunity cost to capital invested in machinery• Could reflect the loan rate or
the return on the next best alternative, depending on the source of capital
Calculating interestDetermine average value of machine ◦ (Cost + Salvage Value)/2
Multiply by the interest rate
Divide by annual hours of use to get machine interest cost per hour
Calculating interest examplePurchase price: $40,000
Salvage price: $10,000
Average value: (40,000 + 10,000)/2
Average value: $15,000
Multiply by interest rate: $15,000 x 0.05 = $750 per year
Divide by hours of use to get interest cost per hour
OR Divide by acres of use to get interest cost per acre
Machinery insurance costs•Annual charge to cover liability coverage, and losses due to collision, fire, theft, hail or wind
•An insurance cost should be included in the ownership costs even if the owner carries no actual insurance because losses can be expected over time
•Ball park cost of 0.5% of machine’s average value
Housing expenses•Tractors left outside had a 16% lower trade-in value after 10 years then those left inside in a national study
•Ball park cost of 1% of annual value could be used
•More accurately, you could estimate the annual cost per square foot for the machine shed and multiply this by the square footage the machine needs
Operating costs for machinery•Directly related to level of use
•Zero if machine is not used
•Repair costs – difficult to estimate• Typically increase over time • Best source is detailed records of actual
repair costs under existing levels of use, maintenance, and cropping pattern
• Include both parts and labor
Fuel and lubrication costs•Depends on engine size, load, speed, and field conditions
•Farm records are the best source of data
•Estimates can be made based on PTO hp:• Gallons per hour = 0.060 X PTO hp (gasoline)• Gallons per hour = 0.044 X PTO hp (diesel)
•Costs for lubricants and filters average 10 – 15% of fuel costs for self-powered machines
Acres per hour calculation•Acres per hour = (speed (mph) x width (ft) x efficiency (%))
8.25
Example: how many acres per hour can you cut with a swather that is 12’ wide, operated at 8 mph, with 82% efficiency?
8 x 12 x .82
8.25= 9.54 acres
Benefits of leasing•Reduces the amount of capital tied up in fixed assets
• Generally lease payments are lower than a loan payment would be for the same equipment
•Reduces the risk of obsolescence
•Leasing may have a lower after-tax cost for operators with little taxable farm income, thus cannot take advantage of Section 179 deductions
•Lease payments can be subtracted as an expense from taxable income• Leases must be set up correctly in order to do this; restrictions apply
Leasing machinery: capital lease•In a capital lease, the machine can be purchased at the end of the lease term
•In order to be able to deduct capital lease payments on your income tax, this purchase must be OPTIONAL
•Otherwise, the lease is seen as a sales contract, and depreciation and interest can be deducted from your income taxes, but not the lease payments
Disadvantages of leasing•Leasing machinery is not well established in many areas
• Machines and models you need may not be available
•Lease payments are operating expenses, and a late payment may cause cancellation of the lease
•Operator may not be able to cancel the lease without paying a substantial penalty•Leasing does not allow the operator to build equity in the machinery
Example: Break-even point for ownership•Calculating break-even:
total annual fixed costscustom rate – variable costs per unit
•Ownership (fixed) costs for a combine are $21,579 per year.
•Variable costs are $7.82 per acre
•Custom hire rate = $30 per acre
$21,579 = 973 acres$30 - $7.82
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Replacement decisions: when to replace•Present machine is worn out•Machine is obsolete•Costs are increasing with the current machine•Capacity is too small•Income tax considerations
• In a high profit year, machines may be replaced to take advantage of tax reductions
•Cash flow• Replace in years of above-average cash income
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Strategies for machinery replacement•Keep and repair
• Usually the least-cost strategy, particularly if repairs can be done on the farm. Risk of a breakdown at a critical time might be high, however
•Trade often• For operators who desire newer and more reliable
equipment. Leasing may be a good strategy.
•Trade when income is high
•Invest each year
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Activity Based Costing (ABC)Calculate your costs by operationAllows easy comparison for decisions such as ◦ Custom hiring machinery
operations◦ No-till versus conventional tillage◦ Potential savings from changing
machinery
Operation Cost/AcreFall Plow $18.00Spring Harrow 3.50Spring Cultivate 5.00Cultivate/Spray Incorporate 6.502nd Incorporation-Cultivator 5.00Seed-Conventional Drill 12.00Harrow 3.50Roller/Packer 3.00
Total Costs Per Acre $56.50
Costs/Acre* - Conventional Seeding - Spring Peas
Costs derived from activity based accounting/industry standard rates
Operation Cost/AcreFall Heavy Harrow $4.00Fall Roundup-Green Bridge 7.00Custom Hire-Direct Seed Drill 17.00Harrow 3.00Roller/Packer 3.00
Total Costs Per Acre $35.50Other Qualitative Factors: less water loss, less compaction, less erosion risk
Costs/Acre* - Direct Seeded Spring Peas
Costs derived from industry standard rates
Savings/Ac= $21
Information Needed to Do Analysis: Operating Costs◦ Fuel◦ Consumption per hour◦ Cost of fuel
◦ Labor cost◦ Primary operators◦ Support personnel
◦Repairs and Maintenance◦ Parts & Labor
◦Other Equipment Support, Overhead Costs
ABCS OF FARMING - COPYRIGHT 2007 WITTMAN CONSULTING
Information Needed to Do Analysis
Productivity of Machine Operation◦ Working width◦ Speed◦ Field efficiency %◦ Large fields increase efficiency %◦ Precision ag tools increase efficiency %
◦ Annual usage of power unit – all operations
ABCS OF FARMING - COPYRIGHT 2007 WITTMAN CONSULTING
Information Needed to Do AnalysisOwnership costs◦ Cost of power unit/implement◦ Planning Horizon/useful life◦ Salvage value◦ Cost of capital or borrowing◦ Insurance & housing costs◦ Tax rates
WARNING: Use YOUR costs◦ NOT economic costs from someone
else’s data◦ NOT replacement cost
Annual usage of power unit – all operations
ABCS OF FARMING - COPYRIGHT 2007 WITTMAN CONSULTING
System 8: Organic Winter Wheat (Madsen)Total Total
Variable Fixed Machine Materials/ Cost ofOperation Date Cost Cost Cost Labor Services Operation23'Chisel Plow 9/16-17/08 2.81$ 2.52$ 5.33$ 1.86$ 7.19$ 53' Rotary Harrow 9/17/08 1.32$ 1.63$ 2.95$ 1.01$ 3.96$ 53' Rotary Harrow 10/7/08 1.32$ 1.63$ 2.95$ 1.01$ 3.96$ 30' Disk Drill 10/20/08 3.93$ 3.22$ 7.15$ 1.83$ 62.00$ 70.98$ 100 lbs Madsen @ $0.62/lb50' Rotary Hoe 4/10/09 0.57$ 0.69$ 1.26$ 0.31$ 1.57$ 50' Rotary Hoe 5/4/09 0.57$ 0.69$ 1.26$ 0.31$ 1.57$ 50' Rotary Hoe 5/13/09 0.57$ 0.69$ 1.26$ 0.31$ 1.57$ 50' Rotary Hoe 5/26/09 0.57$ 0.69$ 1.26$ 0.31$ 1.57$ 25' Combine (grain) 8/25/09 6.37$ 15.32$ 21.69$ 3.02$ 24.71$ 3/4-Ton Pickup Annual 0.53$ 0.43$ 0.96$ 1.20$ 2.16$ Miscellaneous use.Overhead Annual 0.93$ 0.56$ 1.49$ 5% V.C. & LaborLand Taxes Annual 5.50$ 5.50$ Land Cost Annual 60.00$ 60.00$ $1,500 times 4%.
Total Cost 19.49$ 93.01$ 46.07$ 11.73$ 62.00$ 186.23$ Variable Cost 93.21$ (including labor & materials
Grower Example: Derek SchaferUses Activity Based Costing by machine
Developed tools for comparing leasing vs purchasing
Comparison of direct seeding vs conventional
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