BEWARE REPLACEMENT TRAP
Ageing machinery is being
made to work harder and
longer on many farms and
adequate provision for
eventual replacement must
be made. Suzie Horne
asks Gary Markham for
INVESTMENT decisions have been put off for far too long. Is it time to end the depreciation holiday? The answer is probably yes, but its never that simple, says Gary Markham of Grant Thornton.
"It is certainly time for a reappraisal of attitudes to machinery operation, ownership and finance.
"If you can continue putting back in a capital amount equivalent to the target depreciation – often in the form of the capital element of your HP repayments – then its viable and you will be holding your own."
But with incomes and profits having suffered such prolonged pressure, there are many who have been forced to let this slip. One year is manageable, but any longer and it becomes a deep hole to climb out of, warns Mr Markham.
For combinable crop farms, the capital sum tied up in machinery is typically in the region of £494-£618/ha (£200-£250/acre). Target management depreciation for these businesses would be about £74-£86/ha (£30-£35/acre), says Mr Markham.
"If you take the scenario of the past few years, the weighted average machinery depreciation of combinable crop farms in the Grant Thornton client database is around 18%. That figure is the average drop in value on a reducing balance basis and is based on tractors and combines at 15%, other equipment at 20% and farm vehicles at 25%."
Applying that average figure on an area basis, first year depreciation on capital invested in machinery at £200/acre is £36/acre, taking the value of the investment down to £164/acre.
"Another year and another £30 off the figure brings it down to £134/acre, while in year three it drops to £110/acre. Its frightening and a big hole to get out of. But if your back is against the wall then it may have been the only route to take."
However, there may be several answers. The most unlikely one at present is that the financial performance of combinable crop farms will allow them to catch up with their deferred machinery reinvestment, he says.
"Decisions vary from business to business, but the answer may lie in a combination of partial retention of existing machinery, partial sale and part investment.
"I can get that £200/acre figure down to £150 on many farms by forming a machinery syndicate with suitable neighbours or near neighbours. Contractors are another alternative."
For some there is a middle way. "Keep a good tractor, drill and sprayer and do these operations yourself. Use one of the many alternatives for other operations. That way you remain in charge of the key elements through the season."
But anyone considering selling machinery or restructuring in any way should seek tax advice and, in some cases, legal advice on their proposed route. Mistakes can be very expensive, he warns. *
• Do a five to eight-year capital budget to see when major machines will need to be replaced and at what cost.
• Cost main items of machinery on a per hectare basis. Account for the cost of capital, depreciation, insurance, fuel, labour and repairs.
• Compare your own costs/ha with alternatives, such as machinery rings, syndicates, neighbour agreements or contractors.
• Are there "luxury" or under-utilised machines in your yard? Selling could release capital and save on running costs.
• If you are reinvesting, make a proper assessment of the cheapest way to do this. Ask the finance company for the APR. Are there tax and timing considerations?
Has capital replacement been allowed to slip? It can be a deep hole to climb out of, warns Grant Thontons Gary Markham.