Analyzing machinery costs

METHODS FOR CALCULATING AND COMPARING COSTS

KATE PAINTER, UNIVERSITY OF IDAHO

Do direct seed systems save money?

Answer: It depends!

•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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0 Acres or units of output

Cost

per

uni

t ($)

Custom hire

Machine ownership

Breakeven

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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

www.IdahoAgBiz.com

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

Enterprise budgets

Machinery variable costs

Machinery fixed costs

Average returns by rotation:

Grower Example: Derek SchaferUses Activity Based Costing by machine

Developed tools for comparing leasing vs purchasing

Comparison of direct seeding vs conventional

Cost for cultivator, pulled by 450 hp tractor:

Comparison of conventional vs no-till operations for wheat:

11% savings for no-till production

Kate PainterExtension Ag Economist

Cell: (509) 432-5755 Email: kpainter@uidaho.eduWeb: www.IdahoAgBiz.com