Grains Research and Development

Date: 01.07.2013

Machinery replacement decisions

Author: ORM communications

Key points

  • Put the farm business machinery replacement
    policy and replacement schedule in writing
  • This can provide the basis for analysis of financial
    and risk considerations
  • The policy and schedule can help focus purchase
    decisions on farm efficiency and profitability

A combination of complex emotional and business considerations influence decisions about machinery purchases. Aside from buying land, machinery is the single largest investment most growers make and requires substantial capital.

However, Rural Directions consultant Patrick Redden suggests that machinery should be managed as a separate business entity, an exclusive profit centre, not just as capital integrated with the rest of the farm assets. In this sense, a business should seek the most cost-effective way to complete its operations.

“All too often farmers decide to purchase machinery because they can, not because they should,” Mr Redden says. While government rebates, good deals and discounts will come and go, a machinery replacement policy can remove the emotion and provide guidance that reflects the strategic requirements of an individual business over the medium to long term.

Write it down

A machinery replacement policy captures the philosophy of a business towards machinery upgrades and renewal. It is written down so that it can be shared easily with stakeholders within and external to the business.

The policy should be specific to an individual farm business, and will provide a practical reference as reassurance that the business is ‘on the right track’, regardless of what the neighbours are doing. A machinery replacement policy should consider:

  • individual business case and budget;
  • task efficiency objectives;
  • proactive management of risk;
  • capacity to manage breakdowns;
  • business’s desired image;
  • machinery brand preference;
  • upgrade frequency;
  • workplace health and safety;
  • personnel productivity;
  • ease of employee use and understanding; and
  • personal goals.

“Many farmers already have a good grasp of these criteria, but often it is all stored in their head,” Mr Redden says. “Discussing the policy with team and family members will increase the depth of thinking involved and the commitment to the overall strategy.”

Writing down the policy also adds discipline and rigour to the decision-making process and provides a guide for the future. A machinery replacement policy should be reviewed every two to three years, or as the business changes.

Table 1: An example of a machinery replacement schedule.
 Item Annual usage
Change over policy
Current usage
Change over budget ($)
 Year
 2013 2014
2015
2016
2017
2018

 
2019

 Boomspray                      
 Chaser bin        45,000
 Y            
 Auger        25,000
 Y            
 Airseeder box        40,000
   Y          
 Airseeder bar    24,000ha
   200,000
           Y  
 Airseeder tractor        200,000
           Y  
 Harvester  400 hours
 1600 hours
   150,000
       Y      
 Truck        350,000
 Y            
 Sprayer – tractor*        60,000
           Y  
 Sprayer – self propelled**        300,000
             
 Spray tractor        100,000
           Y  
 Workshop upgrade        120,000
   Y          
 Silos        150,000
             
 Ute      208,000km  20,000
           Y  
 Ute #2      140,000km  20,000
   Y          
 Twin-cab ute        20,000
             
 Car    150,000km    20,000
     Y        
 Silos at 130/t        60,000
     Y  Y      
 Tandem trailer (half share)        10,000
   Y          
 FEL/forklift/telehandler        100,000
     Y        
 Sheep yards portable        5000
   Y          
 Windrower sprayer                      
 Total        1,995,000
             
 

Replacement schedule

A consultant or accountant can be useful in helping put together a machinery replacement schedule, which should be tailored to the farm business. Together, a replacement policy and schedule provide a solid foundation for making effective decisions about machinery purchases. “By considering what the likely needs of the business are now and into the future, priorities can be clearly identified and reactive purchases avoided,” Mr Redden says.

Table 1 provides an example of a machinery replacement schedule, outlining the expected time frame and costs. “This schedule can then be used in conjunction with bank reviews and business plans to provide a better understanding of the future capital needs of the farm,” Mr Redden says.

A case study

The following example demonstrates how a purchase decision may be analysed.

A farm business is deciding whether to purchase a new or second-hand truck, or to continue using a contractor during grain harvest. The business does not currently own a truck.

A new prime mover and two trailers would cost $443,000 plus GST. The business currently spends $78,000 a year on freight to carry 4800 tonnes, or $16.25/tonne. On the face of it, a new truck would pay for itself in roughly five years, but this may not reflect the ongoing cost of ownership. It is important to undertake a complete analysis. The particular business also chooses to consider:

  • a desire to control the whole logistics process;
  • a desire to have the flexibility to blend grain on-farm;
  • the concern of potential risks with a second-hand truck;
  • an underlying desire to purchase a new truck; and
  • the potential for tax savings.

The first step in the comparison is to analyse the total costs of ownership, including annual depreciation, interest, insurance, registration, annual repairs and maintenance, fuel, labour, and values for risks, penalties or timeliness.

Table 2 outlines a comparison between purchasing a new single truck, a road train or a second-hand truck.

The total cost of ownership can also be divided by various contracting rates to look at breakeven tonnes. In this case, the breakeven tonnage for the road train at $14 is 5656t, while for a second-hand truck the breakeven point is 3636t. This means a new road train would need to haul at least 5656t a year to be more cost effective than a contractor carting the grain.

Financial information can then be evaluated against other considerations, which in this case include several key risks.

Grain delivery risk

The misclassification of grain delivered in a ‘dump-and-run’ manner is a significant concern for this business. Having staff cart the grain could help manage this risk and increase revenue, providing the truck driver has been adequately trained.

Compliance or obsolescence

Annual vehicle registrations and inspections differ from state to state and compliance can increase ownership costs. The risks of receiving a defect notice, or of being given a non-roadworthy certificate can increase with older trucks.

Breakdown risk

Older or poorly maintained vehicles are more likely to break down. A breakdown during harvest would incur substantial costs to either the owner or contractor.

Workplace health and safety

The cost of managing personnel stress and safety risks can be difficult to quantify. Difficulties sourcing a truck driver during harvest could lead to safety issues for existing staff.

Table 2: Annual cost of ownership comparison between new single truck, road train or second-hand truck.
   New single truck
Road train
Second-hand truck
Depreciation   $10,000  $10,000  $2000
 Interest cost $13,600 $13,600
 $4760
 Insurance  $2000 $2000  $1400
 Registration  $2847  $5184  $2847
 Repairs and maintenance  $3000  $3000  $10,000
 Fuel  $12,000  $12,000  $12,000
 Labour  $10,000  $8000  $10,000
 Trailer  New  New x 2
 Second-hand
 Depreciation  $1500  $3000  $1200
 Opportunity cost  $7400  $14,800  $3200
 Insurance  $800  $1600  $500
 Registration  $1500  $3000  $1500
 Repairs and maintenance  $1500  $3000  $1500
 Total cost of ownership  $66,147  $79,184  $50,907
 Potential volume carted per truck per annum  3500 tonnes
4800 tonnes
3500 tonnes
 Cost of ownership per tonne  $18.90  $16.50 $14.54
 Breakeven tonnes @ $14.00  4725  5656  3636
 Breakeven tonnes @ $12.00  5512  6599  4242
 

Timeliness risk

When deliveries are unable to keep up with the harvest rate, it creates a timeliness risk.

So although the second-hand truck option is the least capital intensive, the business may decide that the potential impact of the risks justifies the higher cost of a new truck.

In the quest to complete a job quickly, a farm business may end up in a financially vulnerable position as a result of poor machinery purchases. Similarly, underinvesting in machinery can lead to poor timeliness and reduced profit.

A machinery replacement policy and schedule provide guidance to help ensure decisions are made with efficiency and profitability in mind. It also assists in meeting the short and medium-term requirements of the business, while helping to prevent spontaneous decisions made in reaction to seasonal conditions or promotions.

More information:
Patrick Redden,
08 8841 4500,
predden@ruraldirections.com

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