Age not hours is key to machinery depreciation

Depreciation of farm machinery cost cereal growers in England £110/ha on average in 2010-11, according to DEFRA’s Farm Business Survey (FBS). In 2006-07 the figure amounted to just £75/ha.


That marks a 47% rise in just five years, by far the biggest increase of all fixed costs. Machinery depreciation is now the largest overhead of all, accounting for more than a fifth of all fixed costs, easily overtaking land, property and general farming outgoings and now double the regular labour bill.


The driving force behind the figures is the spiralling price of new machinery, reflecting increasing global demand for steel from developing economies and also its increased affordability as demonstrated by rising agricultural commodity prices, says Paul Wilson, associate professor of management and economics at Nottingham University and chief executive of Rural Business Research, the body that collates the FBS.


“Actual depreciation levels vary widely between individual farm businesses, but these figures reflect a trend that most growers will recognise,” says Dr Wilson.


However, tackling the problem is not straightforward, he adds. “It is very difficult to benchmark as there are so many variables between enterprises, the key one being soil type.


“People who have above average, but not excessive costs are often doing a very good job, using their investment wisely to carry out field operations at the appropriate time and reaping the yield benefits.”


Farm size, perhaps surprisingly, appears to have little effect. “When you look at the figures across small, medium and large businesses there is no common pattern,” says Dr Wilson. “The average figures change very little.”


However, contract costs are significantly lower on large units, averaging £37/ha, compared with £82 and £86/ha on medium and small units, respectively, he points out.


“This shows these smaller units are not benefiting to the same degree from their machinery and their depreciation costs are somewhat misleading. Adding back the contract charge shows their overall machinery costs are considerably higher.


“Arguably they are over-mechanised compared with their bigger neighbours.”






































Tractor depreciation: estimated trade-in value of 175hp tractor as % of discounted new price*      
   Age when sold (years)    
Hours worked/year  4  6  8  10
500 72.6 60.3 49.9 41.2 34.1
750 70.6 57.0 45.8 36.7 29.6
1,000 68.8 54.1 42.5 33.6 26.9

*Trade-in value in real terms; discounted price refers to new Case tractor      
Source: Wilson P Journal of Farm Management 2008



 


A key reason is these businesses want to retain a level of independence, but cannot achieve the economies of scale more hectares bring. “As machinery becomes increasingly advanced and expensive, owning it becomes increasingly difficult to justify on smaller farms,” he says.


“Some are choosing to buy when they might be better off building a relationship with a contractor. That is key – you cannot use contractors as a fire brigade – look after them and they will look after you, investing in and planning for the business you put their way.”


Arrangements with neighbours, either by joint ownership with costs divided by hectares worked, or through strategic sharing where each partner owns a different machine, can work well.


“Machinery rings are not the force they once were, though some are doing well and could be another option.”


Hiring in is another method, often adopted by serious arable businesses geared to winter crops during their peak two- to three-month autumn cultivation period. “This really depends on economies of scale – you really have to pile the hours on to make it pay.”


When it comes to driving down depreciation costs on owned machinery such as tractors, ensuring they are used to their full potential is key, says Dr Wilson. When it comes to resale value the key killer is age before hours (see table above), increasingly so as technology develops, he says.


“The same goes for other complex machines such as combines and sprayers.


“Technical improvements mean you can often take these machines to much higher hours than even a few years ago.


“That means they can and must be worked much harder – you have to ask if doing less than 1,000 hours per year in a modern tractor is right. In 10 years’ time the technology will be very dated, which will undercut resale values. Make the most use of them while they are relatively new.”


Bigger machines cost more, depreciate quicker and don’t get used so much, he adds. “Buy the appropriate machine for the job to ensure you are working it to its full potential.”


Age, however, is relative. Five- or six-year replacement policies are now common, with well-maintained machines still retaining good resale values after that period.


“Three-year policies are probably a luxury in most cases these days,” says Dr Wilson. “Some growers relying on a machine to produce high-value crops may be able to justify the high rates of deprecation that result, but most cereals growers would struggle.”


Given their increased reliability, these second-hand machines make sense for smaller growers who would otherwise be saddled with unsustainably high depreciation charges, says Dr Wilson.


“These growers are unlikely to have the need for cutting edge technology of their bigger neighbours, so buying older machines, particularly combines that can keep running reliably into their mid-teens and beyond, can make sense.


“However, there are some good finance packages around for new machinery that won’t be available for the second-hand market, so it is not always clear cut.”


Farmers can use the FBS website (www.farmbusiness survey.co.uk/benchmarking) to benchmark a whole range of financial measures against similar sized farms, including profit and loss account, gross margins and balance sheet as well as performance measures such as machinery depreciation.


Using this system ensures like is compared with like – the FBS uses 20% annual depreciation on a declining balance, based on current (replacement) costs. Some farmers use historic costs, which can underestimate depreciation by up to 20%, or tax accounts, which can greatly overestimate depreciation in the early years, says Dr Wilson.


“However, don’t get misled by fine detail – one farm’s figures may be slightly higher than another’s for reasons already discussed. Benchmarking is a tool that highlights areas that need looking at – there are plenty of pointers to consider to ensure a business is taking the right approach.”








Bank advice: Management of overheads keeps the best at the top of the pile 

The difference between the best and the worst performing businesses is usually down to management of overhead costs rather than the gross margins achieved, and machinery depreciation is no exception, says Allan Wilkinson, head of agriculture at HSBC.


Machinery costs, along with labour, are a key differentiator, says Mr Wilkinson. Businesses that get them right and keep them under close control are the ones that are driven and focused on profit. Importantly, he adds, they are flexible on how they achieve that control – that is the key to better decision making.


“These businesses constantly measure their machines’ performance, using detailed spreadsheets to monitor running costs, servicing and depreciation using real values and ensuring each machine is covering the optimum number of acres.”


Latest figures from the bank’s Forward Planning 2013 put total power and machinery costs at almost £223/ha, of which about half will be depreciation, Mr Wilkinson notes.


Investing in metal has become very costly. Total Income from Farming figures show why – over most of the past 20 years they have followed the close relationship between the pound and the euro.


The past four years have been different – incomes have been significantly lower than that historic relationship would suggest, mainly because of the increasing cost of dollar-related imports – the cost of bashing metal into machinery has rocketed.


However well focused the business might be, it is always worth re-examining machinery policies at regular intervals. “Contracting in, hiring and leasing are all very valid ways of accessing machinery and savings in depreciation can often outweigh their cost.”


How machinery is deployed is the key test, says Mr Wilkinson. “This will certainly command more attention as prices rise – farmers will have to adopt a more focused approach to individual pieces of kit to optimise its use.”


That could involve sharing a combine with someone in a different geographical area, sharing a machinery fleet with neighbours or sharing contractors that pool the work. “Provided these arrangements are thought through carefully and organised properly so timeliness does not suffer, they can work well,” he maintains.


Assessing whether a business is over-kitted is not simple, he adds. “While there probably is an excess of machinery on many arable farms, it is difficult to measure – given the lack of data and the difficulties of finding true comparables, benchmarking is not simple.


“In addition, people’s perception of risk varies. It is easy to say many have excess machinery capacity, but there is always the fear of not being able to achieve the best results in difficult times.”


How much spare capacity they really need is very difficult to assess, he says.


“I’d encourage customers to use our Forward Planning booklet as a basis for benchmarking, in conjunction with an accountant or consultant who can help provide a detailed analysis.


“Arable businesses tend to be good at matching variable costs to yield expectations. The trick is to match overhead costs such as machinery depreciation as effectively.”

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