Can You Finance the Future?

If you are considering a large equipment purchase, the first question to ask yourself is:

Can I afford it?

If you are not sure how to answer that question, consider the following:

Milk Price Forecasts

Milk prices are determined primarily by market forces in America, and the play between supply and demand is the dominant aspect of these forces. In times of high milk prices, farmers want to make more milk, so production increases. When production increases, supply increases without a corresponding increase in demand, decreasing the price of milk. When that happens, farms may shift their attention elsewhere, decreasing the supply of milk without a corresponding decrease in demand, increasing the price of milk.

Understanding these two effects can help you anticipate the direction of milk prices. The market is self-aware - it understands these principles and acts accordingly.

Milk futures are contracts for milk to be sold at a fixed price at a future date. Milk futures can give you insight into the market’s expectations by tracking the price buyers and sellers are willing to trade milk at a future date.

Talking to others involved in various aspects of the dairy industry can give you a well-rounded and informed view of various variables that impact milk price at any given time. Following milk prices consistently is the best way to understand the market. Read articles by informed authors and pay attention to what they are saying. You will begin to notice themes. The longer you watch the market, the better you will understand the milk market.

Milk Check

A basic understanding of your cash flow can alter your decision regarding down payments.

Your revenue is your milk check (income) minus your expenses (outcome). The timing of milk checks is predictable, but the amount is not as predictable. Your expenses are a bit more complicated, variable, and dangerous. A good way to get started predicting expenses is by reviewing the past twelve months of your bank statements, and totaling cash flows.

That gives you a starting point to predict future cash flows.

Click the link provided for a basic milk check calculator - https://www.gomilkbarn.com/helpful-resources  (you may have to reload the page if it does not work).

Down Payment/Cash Upfront

When borrowing a large amount of money, a bank will often ask for a down payment. This is an upfront cash payment that covers a portion of the equipment being purchased. In some cases, the down payment can be adjusted to fit your needs. In a time of higher interest rates, a higher down payment may be preferred. A higher down payment can potentially lower the interest rate of the lease/loan. It will also lower the amount needing to be financed, decreasing the total amount of interest paid.

To you, interest expense is an unproductive expense, and should be reduced whenever possible, with respect to your cash considerations. If interest rates are low, you may want to decrease the down payment to have a better handle on your cash, as the interest expense in these times is slight.

Interest Rates

Interest rates have risen to their highest levels in about twenty years. This dramatically influences the borrowing environment that you’re dealing with when seeking a loan. When interest rates are higher, the more expensive it is to borrow money for large purchases. If possible, wait to make large purchases during a time with low interest rates.

For example, a five-year lease of a $50,000 skid loader with a 1% interest rate would incur $1,403 in interest.

While the same lease with a 5% interest rate would incur $7,202 in interest.

Making large purchases in times of low interest could save you thousands of dollars… or more. It’s difficult to know when low interest rates will happen in the future, but it’s easy to know when you’re in a time of low interest rates.

Look at the chart below - when Federal funds rates are at 0%, banks are lending at lower rates to compete for business.

Payback Period

Banks want you to speak their language. Payback period refers to the amount of time it takes for an asset to pay for itself.

For example, imagine a parlor expansion costs $200,000 but allows you to produce $100 more milk/day. $100 of milk a day * 365 days a year is $36,500 a year- $200,000/$36,500 gives you a payback period of 5.48 years.