When you sit down across a desk from your equipment dealer, you’re out to get the best deal you can — and your dealer is out to make a profit.
So how can you keep more jingle in your own jeans?
“It doesn’t matter if you pay cash, you finance it, or you lease it,” said Alf Erichsen, who farms near Stettler and was an early investor in Cervus Equipment, which is now the country’s largest dealer group for John Deere equipment.
“You’ll contribute the least if you pay cash. You’ll pay a bit more if you finance it, and you’ll pay the most if you lease it.”
Erichsen, who is still a Cervus shareholder, also worked at John Deere selling and financing equipment — essentially “helping dealers stay solvent dealing with you guys.” But every equipment company uses “basically the same practices,” said Erichsen, who spoke at a Battle River Research Group workshop last month.
While Deere & Co.’s sales have declined over the past three years, it is still making a profit off of every piece of equipment you buy, he said.
“On a $100,000 tractor, Deere’s profits are $5,700,” said Erichsen. “That’s low. Deere’s historic profits are around $9,000 (per $100,000). It’s a tough time to do business, but the investors are hoping that profit will go up.”
While part of the profit in farm equipment sales comes from selling the equipment itself, a good chunk of it comes from financing. In the case of Deere, it’s about one-third of profits, said Erichsen. So “there’s a lot at stake” when farmers sit down with sales reps to discuss financing, he added.
The first thing to consider is interest costs.
“In Alberta, equipment companies have to tell you the interest rate when you finance in a simple percentage. Secondly, they must tell you the total interest that’s on the bill,” he said.
“If you pay in cash, your interest rate is zero. That’s one of the reasons why it might be more profitable to pay in a big chunk and not finance it.”
But on a lease agreement, the interest rate isn’t broken down the way it is when you finance.
“They give you a percentage, but do they ever tell you what the interest is in that number? Nope. They don’t have to,” he said.
Next, you need to look at the capital cost allowance, which allows you to claim depreciation on the equipment.
“If you’re dealing with your accountant, he only understands one kind of depreciation — capital cost allowance,” said Erichsen.
“When you ask him the market value, he’s going to shake his head because market value is a very nebulous thing. It depends on the usage of the tractor — did it run 200 hours a year or did it run 1,000 hours a year? How was it looked after — is it banged up and beat up? Was the oil ever changed in it? All these things will have an effect on its market value.”
Generally, farm equipment companies will depreciate leased equipment more, so the payments will be lower and “that lease is going to look good.” And a lease is tax deductible — “the big selling point of a lease.”
“The net result is you have a tax savings, you have a slightly lower cash expenditure, but there’s something wrong here with this calculation,” said Erichsen.
At the end of the day, the farm equipment company owns that machine — and benefits from claiming the residual value of that piece of machinery. For example, in 2016, the total residual values on five-year leases at John Deere were $4.4 billion. Broken down over five years, that’s $869 million per year.
“Damn near one year of Deere’s profits are tied up in those residual values,” said Erichsen.
“Now do you understand why Deere wants you to lease it? They make more money.”
So if you’re going to lease equipment, you need to think about how you’ll be using that equipment.
“You lease something you’re going to run the hell out of and wear out quick, and it’s not going to be worth a hell of a lot at the end. You should finance those things that have high residual value.”
But when you finance your equipment, what you’re really buying is time, he added.
“The question then becomes how much time did you buy?”
A 20 to 30 per cent down payment “buys you no time,” so at best, “you’re getting four years on a five-year contract.”
“You’re going to make payments every year, so sometime after two years, you’ve paid for half of it. If you really want to get technical, you’ve bought about two years for the average four-year term,” he said.
But you can get around that by buying the equipment outright.
“If you made no purchases for two years and gave up the two years of financing, you can probably go back and just buy it,” he said.
“The only way to do that is to go back in your books and add up what you’re spending on principle payments, and see what that would buy you if you just bought outright with cash.”
That might not be an option for growers with cash flow problems, so ultimately, you need to decide which option works best for your own operation, he said.
“There’s no simple answer. The answer is various shades of grey.”