Everyone I speak with in the machinery game is talking about how little purchasing activity is going on right now. Not surprising I guess when you consider the feasting that occurred post-COVID, driven by the rapid fire depreciation write down.
So I am not sure if we are now operating in the new normal relating to machinery purchases, but it seems to me that people are back to just buying what they need when they need it. Now assuming this continues and the second-hand market remains a ‘buyers market’, it is a good chance for farmers to reflect on how they go about funding purchases, especially broad acre cropping farmers with grain to sell post-spring.
I see plenty of farm balance sheets with long lists of equipment finance (EF) entries. This is understandable if you are purchasing new gear at very low interest rates, however for secondhand equipment where rates tend to be much higher, EF can have a habit of biting hard over time, especially if you run into a lean patch.
I think many people underestimate the cost of EF, especially on second-hand gear. It’s not always easy to see but I think the question you should ask when financing something like a secondhand tractor over 3-5 years is what will the true cost be. How this is calculated depends on lots of things like; are you paying a deposit, what are the fees involved, what is the base-line interest rate, and is there a balloon payment at the end?
The reason it’s worth asking that question is whilst the headline rate might seem attractive, by the time you take these other things into consideration it’s not uncommon for the total cost of the financing to be north of 20% of the value of the purchase…often higher if you take into account costs associated with missing payments or break costs if you decide the sell the equipment.
The other aspect to consider is the repayment schedule. EF needs to be paid for and things can get slippery pretty quickly if you start missing instalments. There is little wriggle room for a lean spring or livestock prices coming off, those payments are expected to just keep coming. As a result, this can create the need for other sources of funding to enable you to keep the business running while you maintain your EF payments.
If you can manage this via your overdraft with the bank, this can work fine, but if that’s not an option, the cost of finding bridging funding can be greater than the rate you pay on EF. Many people forget to add this into their thinking when they use EF over long periods. The potential cost (and how you manage it) of bridging the gap on your EF payments should be considered before you lock in.
So what does this mean? Maybe the first questions (and I think many people are asking this right now) should be ‘Do I really need this equipment?’ and ‘Will what I already have do the job?’. If the answer is yes you need it, then start with the cheapest way – can you pay for it outright?
If you can’t do that I think the next best thought process is to work out how you get it paid down as quickly as possible. This will normally be by an overdraft extension or via a specialist short-term funder who might bridge the deal until you get your next injection of revenue (eg post-harvest).
Whilst your overdraft will always be cheaper (but not always easy to access) shorter-term funding options can be useful. They might look more expensive if you think in terms of rate, but if you do the maths they often end up quite a bit cheaper over the long term. Shorter-term options also enable you to be a bit more disciplined about managing your finances in good times and enable you to keep the powder dry on your overdraft so that you have more room to move in lean times.
Equipment finance has its place. Done well it can be really useful. All I suggest is next time you are looking at options, ask yourself or your accountant what is the true cost associated with this rate. Of course, you ask this question after the most important one…do I really need this piece of kit?