Analyzing machinery
costs
METHODS FOR CALCULATING AND COMPARING COSTS
KATE PAINTER, UNIVERSITY OF IDAHO
Do direct seed systems
save money?
Answer: It depends!
Impacts of machinery costs
•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
Estimating machinery costs
•Infrequent but large cash outlays
• $100,000+ for a tractor, $300,000+ for a combine, $200,000 for a selfpropelled 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 interest
Determine 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 example
Purchase 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 costs
custom 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
$30 - $7.82
= 973 acres
17
Cost per unit ($)
0
Custom hire
Machine ownership
Breakeven
Acres or units of output
18
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
19
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
20
Activity Based Costing (ABC)
Calculate your costs by
operation
Allows easy comparison for
decisions such as
◦ Custom hiring machinery
operations
◦ No-till versus conventional tillage
◦ Potential savings from changing
machinery
Costs/Acre* - Conventional Seeding - Spring Peas
Operation
Cost/Acre
Fall Plow
$18.00
Spring Harrow
3.50
Spring Cultivate
5.00
Cultivate/Spray Incorporate
6.50
2nd Incorporation-Cultivator
5.00
Seed-Conventional Drill
12.00
Harrow
3.50
Roller/Packer
3.00
Total Costs Per Acre
$56.50
Costs derived from activity based accounting/industry standard rates
Costs/Acre* - Direct Seeded Spring Peas
Operation
Cost/Acre
Fall Heavy Harrow
$4.00
Fall Roundup-Green Bridge
7.00
Custom Hire-Direct Seed Drill 17.00
Harrow
3.00
Roller/Packer
3.00
Total Costs Per Acre
$35.50
Other Qualitative Factors: less water
loss, less compaction, less erosion risk
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 Analysis
Ownership 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)
Operation
23'Chisel Plow
53' Rotary Harrow
53' Rotary Harrow
30' Disk Drill
50' Rotary Hoe
50' Rotary Hoe
50' Rotary Hoe
50' Rotary Hoe
25' Combine (grain)
3/4-Ton Pickup
Overhead
Land Taxes
Land Cost
Total Cost
Variable Cost
Variable
Date
Cost
9/16-17/08 $ 2.81
9/17/08
$ 1.32
10/7/08
$ 1.32
10/20/08 $ 3.93
4/10/09
$ 0.57
5/4/09
$ 0.57
5/13/09
$ 0.57
5/26/09
$ 0.57
8/25/09
$ 6.37
Annual
$ 0.53
Annual
$ 0.93
Annual
Annual
Fixed
Cost
$ 2.52
$ 1.63
$ 1.63
$ 3.22
$ 0.69
$ 0.69
$ 0.69
$ 0.69
$ 15.32
$ 0.43
$ 19.49
$ 93.01
Total
Machine
Cost
$ 5.33
$ 2.95
$ 2.95
$ 7.15
$ 1.26
$ 1.26
$ 1.26
$ 1.26
$ 21.69
$ 0.96
Total
Materials/ Cost of
Labor
Services Operation
$ 7.19
$ 1.86
$ 1.01
$ 3.96
$ 1.01
$ 3.96
$ 1.83 $ 62.00 $ 70.98 100 lbs Madsen @ $0.62/lb
$ 0.31
$ 1.57
$ 0.31
$ 1.57
$ 0.31
$ 1.57
$ 0.31
$ 1.57
$ 3.02
$ 24.71
$ 1.20
$ 2.16 Miscellaneous use.
$ 0.56
$ 1.49 5% V.C. & Labor
$ 5.50
$ 60.00 $1,500 times 4%.
$ 46.07
$ 11.73
$ 5.50
$ 60.00
$
62.00
$ 186.23
$ 93.21 (including labor & materials
Enterprise budgets
Machinery variable costs
Machinery fixed costs
Average returns by rotation:
Grower Example: Derek Schafer
Uses 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 Painter
Extension Ag Economist
Cell: (509) 432-5755
Email: [email protected]
Web: www.IdahoAgBiz.com