She Thinks My Tractor’s Sexy – When buying equipment, who sets the price?
‘Tis the season; just as Christmas comes around every December, equipment quote season comes around every October. One would think that consulting would be more crops driven, but in today’s landscape, the number of decisions regarding labour and machinery outranks most grain discussions. After all, as farmers, most are strongest at “growing grain.” The business side of agriculture is where many operations start to see cracks. And these million-dollar decisions are not as easily fixed in one year, unlike the next crop grown.
So, as I run my fifth X9 deal this month, I pondered a blog that would help level the playing field. After all, whether it be retail price, trade value, financing costs, or other terms and conditions, every deal is different, and for a producer, this can be the most daunting task. We never want to know we are losing a deal, so how do you properly analyze an industry where machinery prices are constantly moving and technology is constantly evolving. Let me share.
The Deal Itself
In most instances, the first analysis done is the net price or net cash effect. The actual purchase price or trade values are seen as slightly irrelevant, and the net effect is the true measure of the deal, whether good or bad. I have nothing against this practice; it just makes it hard to analyze what you are giving up to maintain your financial position. Many farms will eat away equity in the deal without knowing it until two deals later when you have no equity to use as a down payment.
We want to know what we are being charged for the hours we have used our trades and what you are charging us for the new hours. Most of our deals are run in per-hour numbers as things make it most easy to not only benchmark but to know what our true depreciation costs are. All accountants currently use some type of percentage or amortization schedule to depreciate assets. We would rather know how much per hour it costs and how many hours per year we are utilizing each primary piece of equipment (tractors, combines, sprayers, drills). With each deal we make, we get a stronger handle on the cost per hour to run our own machines.
Back to the negotiations. By identifying what the dealership charges us for the hours we have put on our trade machines, we can compare to other farms that have done the same deals. This makes the value of our used equipment a benchmark among other farms of our size and management. This is strong as many machinery deals are done by manipulating both the new price and the trade to come to a net agreement. Even with the inflation adjustments in 2022, we have been able to compare across trades and new hours to ensure we are getting the best deal possible.
Now, in terms of upgrade hours, what are we getting from the new machine? The easiest deals to run are when there are no “upgrade estimates”. This is the number we must allocate to a new technology or larger capacity machine on a trade. If we are trading apples for apples, the analysis is bullet-proof. If we go from apples to oranges, further research must be done to identify what these upgrades are worth.
Once we have figured out the price you pay for the upgrade, we now have another value that can be benchmarked. What is each dealership charging to go from your trade machine to the new one per hour? In the end, when we remove the new technologies or increased capacity, you are merely trading for a lower-hour machine. So, this cost per hour should be consistent across similar farms.
As I learned in my past life as a public accountant, benchmarks are a valuable tool when understood. When you take into effect the qualitative items of an equipment deal and then run the per hours for quantitative, we are comfortable getting the best deal possible. This is the difference between using “data” or your “gut”.
Do you Want to Own your Machinery?
My next question will dictate the structure of the deal once you have agreed upon the price. In your own farm, do you ever want to own a “depreciable asset”? No different than the pickup truck I continually upgrade every couple years and never tow anything; is this a luxury or a necessity. When we analyze machinery deals, what you will find is almost always the return on investment on equipment is negative. When compared to land or other investments, why would you ever want to own the machine?
This also ties back to the argument of debt-free versus debt leverage. Many operations have strived to be debt-free seeing this risk as a negative. Most of the farms I deal with directly think that debt allows entrepreneurs to grow. If you can create a return on investment on the farm greater than the current interest rate, why would you not borrow to grow? Not an argument that all will like, but an argument nonetheless.
So, why the discussion on depreciable assets and return on investment? This question will dictate the terms and conditions you are looking for on your equipment deal. Most of my machinery purchases are amortized from 7 to 10 years. This significantly reduces the equity in the machines, but it opens further borrowing power for the next equipment or investment opportunity on the farm. Our goal is never to have equity tied up in equipment; I would rather have it in land that grows in value each year. Or even in a reduction to our operating credit, where the current interest rates continually increase the expense per year.
This is also why many producers are now looking at short-term leases on equipment. The lease rates are competitive with purchase rates, and if you take a large buyout in the end, you can reduce the hit to working capital through lower payments. Worst case, you lose the equity in the machine and gain it in working capital. Best case, interest rates come back down over the lease and when you buy out, you do so at a discounted rate. This is the current trend since the Bank of Canada continues to push rates higher.
So, as the equipment retailers start making their fall phone calls. And as you are informed that supply is short and if you don’t put your name on something, you may not get it. Always remember that some of the top-earning farms in Canada do not utilize new machines. In fact, a tractor, other than horsepower and hydraulic power, has yet to evolve since the first Quadtrac. So, stop looking over the fence at the neighbours. Remember, you are the driver of the car. You decide when to buy, what to buy, and how much you are going to spend.