Know your costs, save smart and build equity, banker advises
Operating costs are typically 55% of gross sales for the large custom harvesters lender John Mortier works with.
That means that less than half of their total income is left to pay for equipment, leases, principal and interest payments and personal withdrawals, said Mortier, vice president of M&I Bank, Appleton, WI.
He analyzed the financial records of three large-operation harvester clients who each gross around $1 million in revenue per year.
But don't take his figures for it — track your own businesses' day-to-day operating costs from the past four to five years, he advised harvesters at the January Wisconsin Custom Operators' conference.
“Use your actual historical costs for percentages in making decisions on adding new equipment, work or additional services to your business.
“Let's say you have the chance to take on a large dairy — 1,600- to 2,400-head. But to do that, you're going to have to add on at least another chopper and some merging and cutting equipment,” Mortier suggested.
The new business, he estimated, would bring in a million dollars, but 55% of that would go for operating costs. That would leave $450,000 to spend on equipment and other costs.
“So if it's going to cost you a million dollars and you want that paid back in five years, you're going to have to pay off $200,000 worth of principal, and the first year, make $250,000 worth of payments.
“It seems like you have to take on more debt than what that job will pay.”
Besides cautioning harvesters to carefully push their pencils before taking on new jobs, he used his analyses to show just where harvesters' operating costs go.
“Of all the operating expenses, labor and benefits account for about 42-45%,” he said. “One thing I'm always asking my guys about: ‘Are your employees actually working or are they filling time?’
“If they're not working, you may have to send them home. That's one expense that's so easy to continue to let creep up.”
Although harvesters pass fuel costs on to clients, they still pay base fuel charges, he said. Fuel, machinery repair and labor costs total 85% of operating costs, Mortier said.
“You can spend a lot of energy and effort trying to manage your costs and look at ways to improve your operation. But if you're not concentrating on those three items, you're spending time that's not going to mean anything to your bottom line.”
To hold down labor costs, start the season with an overall strategy, like sending workers home on rainy days or when the crop isn't quite ready. “It's important to manage this on a weekly basis.”
To build equity in their operations, harvesters must depreciate on a true market value — not a “blue-sky” value, Mortier said.
“Every business is in place to do two things: to make you a decent living and to build a retirement fund or equity you can pass on. When you think about it, outside of your equipment, you basically can sell your customer list. But your list has very little value.
“There is nothing, or very little, that someone would pay you above the actual value of your equipment. So be honest with yourself; what is the true market value of your business?” he asked.
Harvesters should pay off their equipment as quickly as possible, the banker said. He helps his custom clients track the value of equipment as they buy it and until it's traded off.
“Typically on your high-wear items that lose value — choppers and mergers and things like that — I would depreciate anywhere from 15% to 20% per year.” For tractors and other equipment, he suggested around 10% depreciation.
He would try to make sure that the chopper his client paid $350,000 for — and four years later wanted to trade off — would get more than it's worth on the books.
“We'd always be in a position where you are getting more for the trade-in value of that equipment than I have on my balance sheet,” he pointed out.
“I'm trying to measure, when I set up your payments, what this equipment really is losing for value. If it's losing value at somewhere around 20% per year, I'm going to try and pay that off at 25% per year to force equity into your equipment.”Continue on Page 2
Mortier's final suggestion to custom operators: Do all you can to get paid for your services.
“This is going to be more imperative than it has been the last 10 years. By the time you pay your expenses, about 10¢ (per $1 earned) or less is left for you. If there's a $10,000 bill that doesn't get paid, that comes out of your pockets, because everybody else gets paid.”
To recover that loss, a harvester would have to do another $100,000 worth of work, Mortier added.
Know your customers and aggressively follow up on overdue statements; he urges his clients to deal with 60- to 90-day past-due accounts. He also suggests they go to attorneys to help put pressure on customers.
“Some well-heeled dairies can't pay the operating bills this coming year right now on paper. That could change, and you don't overreact on a short-term basis in this business. But this is going to be one of the most challenging years the dairy industry has faced in probably 20 years, and you should know who you're doing business with.”