You're caught up with fall field work and looking forward to a nice Thanksgiving meal with good friends and family. Then the phone calls start: "Jim, you won't believe the tractor I've got sitting here on my lot. This would be a perfect fit for your operation. Come on down, I'll sell it to you for a song!"
With good used equipment piling up on dealer lots, you've likely gotten one of these calls already. And to be honest, you're tempted. Some of your stuff could use an upgrade. Yet, grain prices aren't showing any signs of life, and they may not for another year or two. Do you want to make a capital purchase with profit margins where they are?
Buying equipment these days should be all about improving efficiency and productivity says Iowa State farm and ag business management specialist Kelvin Leibold. If you're trading like-kind equipment for larger capacity or newer equipment for better technology, consider these questions:
-If the upgrade is for larger capacity equipment, does the larger piece of equipment make me more efficient?
-Do I plan to grow the size of the operation and need larger equipment?
-Do I think the new technology or new features will make me more efficient and more profitable?
-Do I think that the current “sale price” is at the bottom of where prices will be in the near future for that type of equipment?
-Does my current equipment need to be replaced due to wear or potential costly repair bills?
-How will this purchase impact my 'burn rate' (defined as working capital/net income loss, the length of time in which a firm’s working capital will be exhausted by ongoing losses)?
-What are the other potential uses for the cash I'm about to spend, and how does this affect my working capital in the short run and the long run? There are other ag and non-farm investments you may consider as well.
"Often assets are purchased as a way to avoid or minimize the amount owed in taxes, but very few businesses fail from paying their income taxes," says Virginia Tech ag economist Dave Kohl. "Pay taxes and invest in productive, needed assets."
Many farmers bought machinery in the past five years and are now refinancing those purchases, likely against land with very little debt, notes Iowa State farm management specialist Steve Johnson. "The strategy stretches out principal payments for a longer period of time, but frees up working capital," he adds.
Pros and cons
Even if your farm is not in growth mode, buying larger equipment may help with the speed of planting and harvest. "Producers needs to ask themselves if they will increase the timing of operations enough to justify the investment," says Leibold.
If you have plenty of working capital and believe you will have opportunities to expand the operation – say, as a result of financial stress from others in your community - then maybe picking up bargain sales will work with that strategy. But there is a catch. Make sure that purchasing “bargain sales” doesn’t deplete your working capital so much that you are unable to take advantage of expansion opportunities when they arise.
Another reason to justify new equipment is a tangible benefit - seed savings, better plant spacing, more information to use to make management decisions, or replacement for labor shortage, for example. All of these benefits should add to profitability.
"We may see some panic selling of machinery from several different sources," says Leibold. "Internet selling now allows buyers to shop all across the country and trucking companies offer transportation and delivery. So you need to determine if the local marketplace reflects the prices of “panic sellers” across the country. Will “panic selling” continue, slow down or increase in the coming months and years?"
Let's say you were already planning on trading equipment in a year or two. The current glut of good equipment available may prompt you to move that schedule up. Another trigger to buy: repairs may more than offset the cost of the trade. Keep in mind that you probably know more about what is wrong with your current piece of equipment than something you buy used.
Besides the working capital question, this decision also comes down to cash flow projections. Sort out your expected profitability scenarios for 2016. If you're sitting on cash and your cash flow projections indicate you will continue to have great cash flow and great debt repayment capacity even with current prices, then you need a smart plan for capital purchases.
Hopefully these ideas can help you sort out the deals that may be dangling before you this winter. Now relax and enjoy some turkey and stuffing. You earned it.