Considerations Before Making Capital Purchases

March 19, 2022
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As you know, every farm is different. Because of this, the considerations for capital purchases vary from farm to farm, but there are some general guidelines everyone can follow to create a responsible expenditure plan. Before purchasing that new tractor, building, or piece of land, creating a plan is necessary to remain financially secure. This plan might include tracking costs, planning for purchases, and securing financing.

Tracking Capital Costs
The best way to track your capital costs and what your finances might look like is to monitor your machinery expenses per dollar of revenue. This will tell you how much you are generating on your farm and how much of that goes towards capital expenditures. David Widmar, an Agricultural Economic Insights co-founder and agricultural economist, claims the most responsible way to do this is to keep the “machinery expenses below 25% of annual gross revenue.” As stated, this may vary from farm to farm, but if you are consistently above the 25% benchmark, you may want to reconsider your capital purchase plan.

Plan for Purchases
Creating a plan for your purchases both short and long term will essentially create your expenditure plan. What you first need to consider is the equipment that needs to be replaced and how much those repairs or replacements will cost. These are immediate needs that cannot be put-off. Once these costs have been calculated, you can put them into your budget to determine your plan for the long-term.

When you create your long-term expenditure plan, you might focus on one type of capital purchase need at a time. For example, you may focus on tractors one year, followed by tillage equipment, and eventually replacing larger expenses such as grain bins. Creating this plan does not prevent unexpected costs, but it gives you a better idea of where to put your money when, so that if those costs come up you can
be prepared.

Securing Financing
Machinery, whether new or used, is going to be more expensive in 2022 than in 2021. In 2021, the prices were similar to 2018, but that will not be the case this year. With these higher costs, the need to secure financing after you make your capital expenditure plan is even greater. There are 5 considerations for securing financing when looking to make capital purchases. These considerations are income, equity, collateral, terms & character.

When you’re looking to get a loan for a capital purchase, a lender will first consider your cash flow. You may be accustomed to looking at this projection for short-term numbers, but the lender will be looking five or more years into the future. Before this happens, you can look at the long-term cash flow projection to be educated about your own numbers before discussing them with a lender.

Essentially, the equity you put in your business is the amount you are willing to risk should it fail. This is not limited to the amount you have personally invested. Equity can come from other sources such as friends, family, or other outside investors. This is important when looking for a loan because lenders will want to know what you have put on the line before they can put something on the line for you.

Lenders will require you to put something up for collateral against your loan in the event your business fails. While this is ugly to think about, it must be considered when you think you really need that new piece of equipment or land. Collateral might be land, buildings, equipment, or livestock. Lenders will want this appraised, and the appraisal will be below market value because lenders cannot get the amount it is worth should they need to do so. When you are asked to put up your house, livestock, or equipment, it may sound scary, but know that it is necessary just like the capital purchase you are making is necessary.

The terms and conditions for a loan is when the lender considers for what the loan will be used. In this case, it is a capital purchase. Since you have a capital expenditure plan, you’ll be able to speak about how this purchase fits into your big-picture budget, ultimately helping to secure your loan.

Your lender will consider your past-borrowing history, or your character when evaluating your operation for a loan. Be prepared for them to complete credit checks and ask for the history of your farm. This assures their trust and confidence in your ability to repay the loan.
With the rise in operating costs in 2022, from machinery to nitrogen, the more you can plan for expenses the better. This includes both long and short-term expenses. Consider which capital purchases can wait until costs are lower, and which are absolutely necessary for the future of your farm.