Why university custom equipment rates are not enough, or are they?

Shay: Welcome back everyone to another episode of the Ag View Pitch, and Chris and I are here today having a discussion on university equipment custom rates and why they aren't enough. Chris, that probably got some people's attention when we titled it that way, don't you think?

Chris: Yeah, it may have, and I don't want to infuriate any university people either, but, uh, what I do want to comment on is, is, you know, I do think the university numbers are good for the database that they are in. In other words, If, if a university surveys 200 people, let's say, and they get the custom rates that some people are paying in addition to the rates that some other people are charging for every pass that they do in the survey, those numbers are really accurate for that database, for that set of producers. However, what I tend to say is that when you look at those numbers and compare them to yours, there's probably a big discrepancy. Your numbers are not necessarily going to match up with those university numbers. And so what people tend to do is default to the university numbers because they have no clue what their own numbers are.

Shay: And one of the questions that we get frequently from producers too is, well, who's taking these surveys? Like, I've never gotten one of these surveys. So is it those that, you know, have registered or say that they have custom work for service, or is it those that have just happened to do custom service? You know, who, who are the people that are taking these surveys? And so when it comes to that cost of production that you're trying to get a baseline from the university, it might not be an accurate representation of what an operation or a farm your size can accurately depict for a cost.

Chris: Yeah. And they do, they do a statistically random sample, but it's, it's just not representational of each of us as individuals, what our numbers are. And so that's really the key thing I think is is what do we need to be doing to get our own numbers and figuring that out?

Shay: Well, and another thing that I want to point out too is with our travels all around the country, sometimes we have people 2, 3, 4 states away referencing the Iowa State University custom equipment rates, or vice versa, you know, pick any university or, you know, any area out there.

Chris: They're in Nebraska and they're using Purdue numbers or whatever.

Shay: Yeah, exactly. And so, you know, it's just something to take into consideration of if you're going to evaluate it that way maybe looking at it specifically for your area, taking the best data that you can, and then potentially looking at a combination of that and comparing it directly to where we're going to head next, to your cost of production. So talk a little bit about how your actual cost of production ties into the equipment rates on custom services.

Chris: Yeah, I think as far as machinery goes, we all need to take a step back and, and start working through a step-by-step approach to really dial in and figure out what our machinery and equipment costs are. And the primary reason is machinery and equipment is the second largest line item expense that we all have in our farm operations. In some operations, I would argue that it's the largest line item expense, and it's also the biggest expense that we can do something about, that we can, that we can track. And again, you know, if we don't measure what our equipment costs are, we can't improve it, and it'll impact when we are trading things and the decisions we make. So what we like to see is when you start tracking that, the first thing that needs to be done is you need to do an appraisal of the machine. Machinery and equipment.

Now, how do you do the appraisal and does it cost a lot of money? Doesn't have to cost anything. You know, you can go to your local equipment dealer and we typically recommend you go to at least 2 local machinery and equipment dealers, get a salesperson that's rep, you know, that's reputable, that does a good job, that you trust, have them come in. You might have to, you know, give them a gift of some sort, but you know, and if they want to sell you machinery, they're probably more than willing to come in. And do an appraisal. And for that appraisal, what we recommend is, is, um, just putting down a list of your equipment, the primary machinery and equipment that you use, and then have a line there beside it and nothing else on the form. And then just give that form to them and say, all right, I want a value on every piece of equipment, but you have to coach them.

You have to say, I want, you know, I don't want, retail, I want a wholesale price, or I want a value on there. In other words, that if I took this mechanical front-wheel drive tractor that you tell me is worth $250,000 and I drive it to your dealership and I pull the keys out and throw them on your desk, you're telling me that's what you're going to write me a check for. And a lot of times what we see is that $250,000 tractor might be on the balance sheet as such for that value, But when that appraisal is properly done, maybe that tractor's only worth $150,000. So now all of a sudden you got $150,000 or you got $100,000 overstated value on a piece of equipment that is gonna impact your balance sheet. But trust me, the bank already is doing that. The bank is already, you know, putting down true values.

And so you really need to figure out what is the real value of all your machinery and equipment by every piece. And, and what it's really worth. And then the key thing there is, is you want to repeat that every year. You want to do that at the end of the year.

Shay: One thing that I want to make a note on, on that, and it's a real-life example that we had in our operation in Northwest Illinois here this last year, was we had this equipment appraisal process done sometime in the middle of June, and when harvest rolled around, we decided that it was time for a new grain head. And I had You know, very, very clearly explained this process, but it's foreign to a lot of these equipment dealers. And when I clearly explained this process, they said, "Yep, we understand." But then when we went to trade in this grain head on a new one, they valued it at less. And so I brought in that actual equipment appraisal and I said, "Well, this is what you valued it at and this was the understanding here." I said, "What's the difference?" And you know, there was just a sense of accountability there that it really held them to the numbers.

And so when it came, You know, and they worked with us and they brought it back to that price because they understood what we were trying to accomplish. And so this year, you know, when we had them do it again, they really understood the process there. So I think having that year-over-year data is crucial in helping to coach them because it's not something that they see a lot.

Chris: Yeah, and one other to add onto that too, Shay, is, you know, that we always try to tell people is that you have Dealer A and Dealer B, And the reason you want to probably use two dealerships is you may have one that's 30 miles one way from you and the other one's 80 miles the other direction. And let's say, for example, you have a combine and the dealer A values it at $250,000 and B values it at $200,000. Well, why is that? Well, possibly You know, one dealer might have extra of those combines sitting on the lot. The other dealer might need one for sale. So all of a sudden the other dealer actually values it a little higher. And then if you just take the average of those two values, then you're gonna be able to really dial in, uh, in dial in your numbers from one year to the next.

Shay: Well, and you mentioned earlier this year over year, so why is it so important to do year over year and how does that depreciation factor into your rates?

Chris: So when you're gonna figure up your cost of machinery and equipment ownership, you gotta look at true depreciation and actual market value. And the only way you know what true depreciation is as opposed to tax depreciation, which doesn't mean anything, or a standard depreciation number, which doesn't mean anything, is that you need to know what the trend line of actual machinery and equipment depreciation is. Because at a certain point, some used equipment might actually appreciate instead of depreciate. And so it's looking at every single piece of equipment every year. And then that also helps you decide, well, when should we be trading something? How long should we be running things? And it just gives you a true picture of what that looks like.

Shay: And some of the other things that are tied in there, Chris, with that depreciation is looking at, okay, you know, the maintenance costs, the repairs, and then also the logistics. You know, talk a little bit about how that should tie into those rates.

Chris: Yeah, so what we look at is what we call kind of your overhead costs, let's put it that way. And so it's basically your RTK on the tractor, it's your idle time, it's your road time. It's just a category that we pull those expenses in that a lot of times people forget about and it's just allocating those costs on a pass. Let's just dive into, to what it looks like to calculate your machinery and equipment cost on a per-pass basis. And that's really the point here. Once you have those values and, and do it the way we just described, as opposed to just using a university number or just guessing on the value of the piece of equipment, now you have an actual value of that machine. So let's say, for example, you're gonna do a planter. So you do the tractor. Let's say the tractor's worth $150,000.

And you put that tractor down as a value at $150,000, then you ask yourself, well, what percent of that power unit is, is the cost? Well, let's say that it's, you know, 50% of that number, um, or whatever it is, you know, you look at a percentage and then you take the power or the, uh, the planter in that case, and it would be 100% of that. So you got 50% of the value of the tractor, 100% of the planter, And then those two numbers then added together, 50% of the tractor, 100% of the planter are added together in addition to fuel, in addition to labor, and in addition to what we call the 25% rule, which is 25% of that total value, which would then cover interest, depreciation, repairs, and inflation.

And that's something that most people don't calculate when you look at true cost accounting, because True cost accounting is going to measure interest, depreciation, and repairs as a, as a hard number, as a true cost number, and that's fine. However, you're eventually someday going to replace that machine, and so you have to factor in somewhere between about a 3% and a 6%, somewhere in that range, inflationary component. Otherwise, what happens is time goes on, you go to trade that machinery, you haven't billed yourself enough for the cost of that pass.

Shay: Right. Well, once you have that dialed in and you look at, you know, the percent use there and really get those numbers where they need to be, you know, how do you go about making the calculations? So maybe you don't know exactly what you're going to be running it over acre-wise. Talk about how it's a little bit of a fluid process on running an analysis, you know, so like with With us using Profit Manager, we say that you're looking out the windshield so you can run scenarios, run projections, run calculations on what you would need to charge for a rate. Then the other thing too is at the end of the year, you can even come back in and say, okay, exactly how many acres did I run this unit over? What were my exact costs? And then what do I need to charge myself as a rate?

Chris: Yeah, exactly. Because that's the biggest, um, component to understanding your cost of machinery operation on a per-pass basis is how many acres did you run that machine over? And so if you, if, if you're, say for example, running that planter that I just used as an example over 2,000 acres and your rate is $22 an acre, but all of a sudden you get a chance to run it over, you rent some more ground and now you run it over an additional 500 acres. That might bring your cost of production down $3 or $4 an acre. But you need to be able to plug in those other costs first, those accurate values of the planter, the accurate values of the tractor, and an accurate percentage of use of that tractor, because that tractor might be 50% on the planter, it might be, you know, 50% on a grain cart or whatever it is. But it's, it's actually keeping track of the hours on those power units.

So you know how to allocate the cost of that power unit from one operation to the next.

Shay: And what that allows you to do then is to compare, you know, owning it versus leasing that power unit and how that looks over time. You know, one of the last things and probably one of the most important that I think a lot of the rates aren't accounting for is, you know, what we call return on assets. And so can you speak to that just a little bit, Chris?

Chris: Yeah. I mean, if you look at the end of the year and you look at how many dollars you have invested in machinery and equipment, And I'm not saying an overinflated number either. I'm saying after you do your appraisals and you get an actual dollar amount or investment of that machinery and equipment, then what you want to do is look at the return that that machinery and equipment has brought back to the operation. And what is the return that machinery brings back is based on how many acres at that rate does it cumulatively bring back. So let's say your planter cost is $25 an acre, your combines or your harvest pass is, is say $50 an acre and all your other passes combined, let's say you're at $125 an acre. You take that number times your total acres and then what's that revenue divided by your total asset value? And are you getting, you know, to a number that, that means something?

You know, is it, first of all, is it a positive number? And then second of all, you know, are you getting the efficiency levels that you, that you want to get in your operation. And again, just like we say in everything that we do, if you can't measure it, you can't improve it. But I would just recommend to people too, to, you know, go online and look at our, um, Profit Manager, um, tutorial, because in the middle of that, um, there is an exact discussion and a video on how to go through this machinery and equipment. And analyze that and how to look at it. And basically, you know, that tool is pretty simple. And really, a lot of this stuff that we measure doesn't have to be super complicated. And we don't need, you know, information overload that bad. We got enough challenges in our farming operations and things to keep track of.

But, you know, if you just do the basics and get the real hard numbers in there accurately, it's not really about the tool. It's about getting accurate numbers. And the only way you get them is to sit down and and make sure you plug in the right numbers.

Shay: Right. And we threw in kind of a fun title here just to get people's attentions. What we don't want to do is knock the universities. You know, they do a great job of providing information and providing some sort of a baseline to farm operations. And we don't want to say that everybody's doing it wrong. What we do want to do is just ensure that you're thinking about it in a sense of, hey, what is the true cost of production, you know, or true cost of operating this equipment on those acres. And, you know, how do we dial it in? What's some of the thought process that, that goes into that? Because a lot of times what we see is just farmers say, well, anything more than what I'm doing right now is additional income. You know, I have this power unit, I can run it at this rate over more acres, and that's additional revenue.

And we just want to make sure that you're thinking through that process and, and making the best decisions moving forward.

Chris: Yeah, what, what's really troubling is a lot of times when we sit down and we actually calculate the real cost of operating equipment on a per-pass basis, and maybe that individual's out doing some custom work for, you know, maybe let's say they're custom harvesting for $45 an acre and their true cost is $55 an acre. So for every acre they harvest, they're going backwards $10 an acre and they're wearing their machinery out on somebody else's stuff. And so that's really what we don't want to see have happen. We want people to dial their own numbers in and figure out what their true costs are. And if they want to go out and do that, you know, for a $10 loss, that's fine. Because in some cases you're out doing some custom work on a farm that someday you hope you can rent. Well, and that's okay.

But maybe that's information that should transparently be provided to the person you're doing the custom work for and say, hey, my cost is actually X. But I'm subsidizing this because I would like to have an opportunity to work with you in the future someday. And so the transparency is there and the openness is there. And again, I just want to emphasize, you know, to people out there that, you know, like you said, Shea, that the university numbers are a guide only. They're not meant to be the numbers that we all use as absolute hard numbers. They're a guide. The absolute hard numbers that we use should really be our own numbers.

Shay: That's great. Any last thoughts there, Chris?

Chris: I think we pretty much hit it. Yeah, I think we're good. I think, you know, if anybody has any questions, please get a hold of us. And like I said, you can watch that video online and that gives you some good information, but we'd sure be happy to answer any questions on any of this stuff too.

Shay: Yeah, be sure to check that out, AgViewSolutions.com. Click on the Profit Manager tab. Chris, I appreciate the conversation here today.

Chris: You bet.

Shay: Good talk. And thanks everyone for listening. We will catch you next time on the Ag View Pitch.