Improving profitability through machinery investment analysis
Author: Will Martel | Date: 19 Dec 2013
By GRDC Northern Region Panellist Will Martel
Machinery investment is one of the most important considerations in a grain growing enterprise and is a key determinant of business profitability.
The question of how much to spend on machinery is regularly discussed in most businesses and investment ‘rules of thumb’ are often applied to assess whether the investment is keeping pace with productive capacity.
Some people use general ‘rules’ such as maintaining machinery investment at around $250-$300/tonne of grain produced but an economic analysis of costs can help businesses determine the real value of individual machines, accurately compare status-quo and replacement scenarios, and assess the impact on overall business profitability.
When it comes to individual businesses there are no hard and fast rules on machinery investment. This will be dictated by the age and condition of the current plant, the impact of the current plant on productivity, and the business’s enterprise mix and productivity goals.
Simple analyses can be done to calculate the return on investment of individual machines and assess whether there is an over or under capitalisation within a business’s machinery plant.
To accurately and fairly assess machinery it is beneficial to make it a separate enterprise and use contract rates for all work the machine does be it on your farm or contracting down the road. This also makes it simpler to do gross margins in each of your cropping enterprises.
Following is a simple example assessing the purchase of a second hand header which can be put into a spreadsheet. Everyone’s input numbers will be different so you apply this example to your own situation by changing the numbers in red which will alter the totals accordingly. The header value is $350,000 and the hectares harvested 2400.
|Income||Contracting @ $50/ha||$120 000|
|R&M @ $8/ha||$19 200|
|Labour||$7200 (all labour associated with header at harvest)
($3/ha@ $30/hr & 10ha/hr)
|Depreciation 10%||$35 000 (often a forgotten cost)|
Remember this is the economic Return on Assets (ROA). It does not include interest or repayments as these are financial costs. If the ROA percentage is greater than the interest rate, the investment is paying itself off.
An ROA gives you the true value of your investment. It lets you compare different options for machinery purchases and also allows you to compare your on farm investments with any off farm investments or investment opportunities.
To make things more confusing the highest ROA may not always be the best option in your business. Sometimes it may be wise to choose a newer/larger piece of machinery with a lower ROA for timeliness or reliability. But these decisions are much easier to make once you understand the numbers.
Will Martel, GRDC Northern Panelist
Wellington NSW 0427 466 245
Sarah Jeffery, Senior Consultant
Cox Inall Communications
07 4993 7135, 0418 152 859