What does your Farm Equipment Cost you to Operate?
Farm Business Management Update, April/May 2005
By Keith Dickinson, Extension Agent, Farm Business Management, Northern District
With the exception of land and buildings, farm equipment can be the most significant financial expenditure for farmers in Virginia. No matter what type of farming operation an individual may have, nearly everyone will have at least one tractor and a handful of implements which are critical to the successful week to week operation of the farm. While estimating what a new or used piece of farm equipment will cost to purchase can be fairly easy, many farm managers are hard pressed to say what that same piece of equipment will cost them per hour or per acre to operate.
Knowing the operating cost of farm equipment is very important for the farm manager. As a key component of the overall cost of production for crops, this information is critical for knowing what a profitable selling price is. With an increasing demand for custom services, understanding equipment operating costs is important in setting custom work rates. Cost of operation is an important factor in evaluating replacement timing and comparing different equipment options as well.
Two basic types of costs are associated with farm equipment: ownership costs and operating costs. Ownership costs are those costs incurred by simply owning the equipment, regardless of the use of the equipment, and are also commonly called fixed costs. The key factors in calculating ownership costs are purchase price, life of the equipment, salvage value, depreciation, interest expense, taxes and insurance, annual use, and housing (if the equipment is stored inside).
Interest costs should be charged to the cost of operating the equipment, regardless of whether the equipment was purchased with cash or credit. This procedure accounts for the cost of giving up the opportunity of using that capital elsewhere in the farm operation. If the same cash could be used to pay off another debt or as an investment or savings, the interest rate relevant to the opportunity should be used to calculate the annual interest costs for the equipment purchase. Inflation should be deducted from the interest rate to properly account for inflation. The average inflation rate for the past 5 years is 3.25%.
Operating costs are the costs incurred as the equipment is used and include such factors as fuel, lubrication, depreciation, labor, and maintenance and repairs: the variable costs of the equipment. Several tools are available to help farm managers estimate the annual operating costs for farm equipment. The American Society of Agricultural Engineers (ASAE) publishes standards for calculating the operating costs of most standard types of farm equipment. A few universities publish tables annually that summarize costs of equipment. Online and downloadable computer programs are available to help determine equipment operating costs. A partial listing of some of these resources appears later in this article.
Depreciation is the cost of wear and tear, age, and changes in technology. Depreciation is calculated by subtracting the salvage value from the purchase price, and then dividing by the number of years the equipment will be in service (economic life). Several sources provide tables that can help determine estimates for salvage values. Since the salvage value will vary both depending on the annual hours of use and on time factors, it is considered to be both a variable cost and a fixed cost.
Good farm records have a place in estimating the operating cost of a piece of equipment. While tables can be found that provide estimates of cost per acre or per hour, there is no substitute for the real world experience of an individual farm manager. Each farming operation is different, with different efficiencies and factors in performing tasks. Therefore, a farm recordkeeping system is crucial in both knowing what farm equipment has cost in the past, as well as estimating what it will cost in the future.
Records should be kept on the number of hours spent and land area covered or tons produced while performing various tasks, such as making hay, planting or grinding feed. A daily diary can be used to record this information. When this information is combined with the previous costs, an accurate estimate of equipment costs per acre or per ton can be developed. While fixed costs can generally only be estimated for future costs, the actual variable costs based on good records are always better to use than estimates from tables. Of course, in the case of new equipment, variable costs such as fuel usage and repairs cannot be accurately estimated from experiences with older equipment, and tables should be used in the first year of operation or for purposes of comparing different options.
Once an accurate estimate of the cost of operating machinery has been determined, the farm manager will be well equipped to make several farm management decisions. For example, if a neighbor approaches a farmer to inquire about having his pasture custom-seeded, the farmer can make an informed decision about the proper rate to charge for this service. Armed with the knowledge of the full cost of production, a crop producer knows what the breakeven price for his crop is and will thereby look for selling at a profitable level. Finally, with the ability to compare different equipment options based upon their cost per acre or per unit of production, the farm manager will know which option will provide the best potential economic return to the farm.
"Estimating Farm Machinery Costs" Iowa State University Extension Publication: http://www.extension.iastate.edu/Publications/PM710.pdf
"Farm Machinery Cost Estimates for 2005" University of Minnesota Extension Publication: http://www.extension.umn.edu/distribution/businessmanagement/DF6696.pdf
Machinery Cost Calculator Program: University of Tennessee: http://economics.ag.utk.edu/mcc.html
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