Contractors Joint ownership Rental Leasing Types of finance
With the cost of tractors and farm machinery commonly requiring the investment of more than $100,000, it always places a strain on the financial wellbeing of any farming operation. By locating the right finance package you will get a much better deal on your purchases.
“Flexibility is the key’ says Roger Brown, UDC Southern Regional Manager. “The agricultural business is seasonal and reliant on everything from the weather to the overseas economy. Because each business is different it is most important to consider is that one size definitely doesn’t fit all - and we want to make sure you’re getting the finance structured to suit your own situation – it’s about making sure you have finance tailored to your individual situation.”
All machinery is designed for a certain number of hours use and needs replacing once worn out. As a general rule, the economical life of a tractor is about 12,000 hours, combines, ploughs, swathers and tillage gear about 2000, and drills and planters around 1000. A systematic machinery replacement programme can make long term planning easier and help make financial decisions for the farming operation less stressful.
Ownership is still the most popular option for farm machinery and may be the least expensive choice in the long run, especially for high-use equipment. However, it does tie up capital and if there are alternative investments that will produce a higher return then other methods of acquiring machinery may be preferred.
Alternatives to purchase may include:
Contractors
Using contractors is a viable alternative to buying plant and hiring labour. Ask yourself what business are you in, what are you really good at, can you hire someone to do a job for you while you concentrate on core business?
The advantages may include:
- You get a machine and an operator.
- No responsibility for operating or caring for the machine.
- Freedom free to work in other areas.
- No long-term capital commitment in plant – hire cost can come from operating capital.
- No repair costs.
- No machinery obsolescence.
- Costs known and budgeted for before work carried out.
- The contractors’ machine is probably newer, better maintained and more suitable for the job.
Disadvantages may be:
- No competent operator or machine may be available when you want it.
- You don’t do the job yourself
- Timing
Joint ownership
Joint ownership is where you can reduce the purchase cost of machinery with one or more other people in a shared purchase. This can be viable where two or more operations can generate enough use to make ownership justifiable when it would not be profitable for either party to own the machine alone.
But, cooperation is absolutely essential as the parties must not only approve of each other’s work habits but also share values about caring for the equipment. Agreement must also be arranged for using the machine and for responsibility for storage and repairs. A written agreement is a must even if the parties are family and should include disposal options.
Rental
A rental agreement secures the use of a machine for a short period of time. Charges are usually made per acre, hour, day, week, month, or season, with a minimum charge even if actual use is less than that specified in the contract.
With a rental agreement:
- You will have responsibility for operation and daily maintenance of the machine.
- You will probably need to carry liability and property damage insurance.
- You may be responsible for major repairs on longer-term contracts.
Consider this option if you:
- Need an expensive machine for only a short period of time each year.
- Want to supplement your present machinery system temporarily, i.e, during a late season or emergency
- Want to try a new technology or production practice on your farm before buying the machine
Leasing
Long-term leasing of farm machinery is becoming more popular, although it has not enjoyed the growth in agriculture as it has in some non-farm industries.
Leases of three to five years in length are most common and like ownership, it gives you complete control of the machine for the period of the lease as well as responsibility for repair costs, and other operating expenses. At the end of the lease period, you may have the options of turning the machine in for a new leased machine, purchasing it, or returning it to the lessor.
Leasing is most commonly used for equipment that has a high degree of rapidly changing technology (ie electronic and computer equipment). This is mainly because it is easier to upgrade to the latest technology when necessary with a minimum of hassle.
Leasing is also used for motor vehicles. There are lots of different types of leases and they all have different terms and conditions which need individual analysis. In most, but not all cases, when everything is taken into consideration, it is better to purchase than lease, but this depends on the financing option used.
So, if you have read this far and are still wanting to purchase equipment, what are the choices?
“Various options are available,” says Louisa Homersham a chartered accountant from Dunedin firm Clarke Craw Ltd, “what is best depends on the individual circumstances. Don’t just go for the easiest or the most accessible – it is important to check out all the options and check your situation out with a qualified chartered accountant who will be able to look at all of the options, take everything into consideration and recommend the best (and most tax effective) solution.”
Cash Reserves (if available)
Keep in mind that these reserves may be needed for other operating costs or to cover income tax payments or GST.
Bank Term Loan
Will attract the lowest interest rate so is usually the best option for financing the higher cost items over the long term. Requires that regular (usually monthly) payments are made.
Loan from a Finance Company
Similar to a bank loan, but usually at a higher interest rate.
Overdraft
Useful for financing on smaller purchases where the funds will be repaid in a shorter time frame. Will attract a higher interest rate than term loan funds. No requirement to make regular reductions but danger that money remains outstanding for some time and the interest cost can mount up. Suitable for short term covering of seasonal cash flow fluctuations.
Hire Purchase
In terms of available products, the credit sale agreement (hire purchase) is probably the most common way to finance agriculture equipment but generally attracts the highest interest rate.
Some vendors offer interest free or lump sum interest free options (eg 1/3 deposit, 1/3 next year and 1/3 the year after). Be aware, however, that often the purchase price has an allowance for interest free arrangements built in. If you ask what the cash price is you may find that it is lower than the original price quoted and obtaining finance through a bank term loan may work out cheaper.
“Every situation needs to be looked at individually taking into account all of the relevant circumstance, “stresses Brown. “For example, it’s a great idea to consider using finance that allows you to structure your payments seasonally – this way you can make payments when the cash is coming in (normally November to April in the agriculture market).
The option of balloon payments can also increase your flexibility – this way you can make lump sum payments when cashflow is good to reduce the term of your debt. Another thing to consider when looking at finance is what will happen if you have a particularly tough year in terms of cashflow – you want to make sure you’ll have support through the tough times as well as the good. Ask your finance provider upfront what sort of things they can do for you during these periods.
Before purchase consider the following questions:
- How much will it cost to own and operate a piece of machinery?
- Are there other ways to do the job and what are the costs?
- How much capital will the purchase tie up and is the investment affordable?
- Can this capital be used more profitably in other areas of your farm business?
- What are the tax benefits for each option?
- Do you have the resources (skill, tools, labour, etc) to operate and maintain the equipment?
- How long before the machine is obsolete?
- Are your farming practices likely to change in the lifetime of the machine?