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 BLOG >> March 2022

Payback Period: Part 2 [Finance
Posted on March 9, 2022 @ 06:15:00 AM by Paul Meagher

In my previous blog I applied the concept of a "payback period" to a farm investment I recently made, namely a portable toilet. In this blog I want to apply the concept to another recent purchase I made, discuss limits to its application, and how it might mislead you into making a bad investment.

Oil Fryer Example

This is the time of year that I like to make investments for our farm property for the year ahead. Our primary focus this year will be hosting on-farm events and hopefully selling our wine (once we get licensed to sell). We anticipate generating at least double the revenue this year from farm events. Some of the investments we need to make in order for that to happen should be made now rather than after revenue is earned from the events. The concept of a "payback period" can useful for determining if certain equipment purchases might be worth investing in or not.

At our last event in 2021, we tested out a 4 gallon oil fryer for making french fries to see if we could offer good quality fries and how people would respond. We had good demand and people enjoyed them. The fryer attaches to a normal propane cylinder and can be operated outside like a barbeque. It fries using 4 gallons of cooking oil which means it doesn't decrease in temperature too much when you dump fries previously soaking in water into it. This means you can potentially keep up a fairly steady rate of fry production however there is some loss in temperature even with 4 gallons of oil. The fryer has two baskets so I try to cycle the baskets so they are not being loaded with fries at the same time and this helps to alleviate that problem and maintains steady production.

We used our last event in 2021 to 1) figure out a process for slicing up the fries efficiently, 2) gauge the rate of production of fries, 3) determine what container we would use and how many fries we would include, 4) what condiments we would offer and 5) what we would price a serving at. This experiment in selling fries was more about testing systems and learning than it was about making money. One thing I did learn was that if we wanted to serve fries to +500 people at an event this year, we would need at least one more fryer. Yesterday I decided to pull the plug and invested in a second fryer with a final price tag with tax of around $720.

Some simple math might be used to estimate a payback period. If we sell a generous serving of fries for $10 per serving, then 72 servings of fries would yield $720 in revenues. Of course we have costs in oil, potatoes, condiments and containers that might mean we have to sell 100 servings to recoup the investment. Nevertheless, I would expect this $720 investment to be recouped on the first outdoor concert event and then we are into revenue generating territory. The fact that an additional fryer would be required to generate more food revenue from fries, and that the payback period is very short, makes it a good investment for the farm. It should be noted that my decision to buy the first oil fryer was based on a food truck selling out 250 lbs worth of fries during our first event so I knew there was good demand for that type of food offering.

Payback Period Limits

Some equipment purchases seem to be more readily analyzed in terms of payback period than others. Some equipment you just need to purchase and it doesn't necessarily generate an obvious payback. An example is a lawn tractor that we need to purchase this year as our existing one is starting to breakdown more frequently and we rely upon it quite a bit. Mowing grass helps make the property look nice and is used to maintain the vineyard and orchard but it is hard to put a price tag on that and it is hard to avoid the need for lawn mowing. In contrast, if I were purchasing a mower that would be used to make square bales then I could use the revenue generated from the square bales to compute a payback period. While I think the concept of a payback period is helpful in making decisions about equipment purchases, it does not obviously apply to all equipment purchases you might need to make to run your business. When the required equipment is not linked to saving or generating money, other factors come into play to determine the particular piece of equipment you might decide to purchase.

Payback Period Failure

I purchased 9 bicycles 4 years back thinking I would rent them from the farm. That business never really took off. As I was purchasing the bikes I was already counting the money I would be making renting them a few times a week. I got the bikes for a good price. A bike shop was getting rid of 5 hybrid bikes it was using for rentals and the rental season was over. I later purchased 4 new mountain bikes for a good price on a year-end clearance sale.

One issue that I didn't really anticipate was the space the bikes would take up, especially if you include helmets, repair stand and extra parts. It almost requires it's own small building. I have been storing them in the barn but they are mostly just taking up space that I would rather use for other purposes. When you take into account the space requirements, and the market cost of storage, the total cost would go up significantly and the payback period would lengthen considerably. So, keep in mind other costs that you might not be considering when you purchase revenue generating equipment, especially the storage aspect.

I also didn't give enough thought to the disadvantages of renting from my farm. The biggest disadvantage is that you have to peddle 2 miles (4 kms) up a fairly steep hill to get to our farm. You have to be a pretty dedicated bicyclist to want to drop off your car at our farm, go downhill for a day riding the countryside, and then finish off your day cycling up a steep hill for 2 miles. For this business to work involves more complex logistics than renting from my farm. I would do better by bringing the bikes to a better location and picking them up from that location. I don't have the time to hang around trying to sell bikes off farm so this didn't happen. The bike rental business is currently a small sideline and I should decide this year if I want to keep doing it or sell my fleet.

My bike rental business was also disrupted last year by a nearby e-bike competitor who dedicated all his time to renting e-bikes and attracted customers who might otherwise have considered renting a traditional bicycle. It is worth giving serious consideration to whether you might not achieve your payback period because your business could be disrupted by other competitors.

Conclusions

Where you can easily apply a payback period to a purchase, and you have some evidence that the equipment will either save costs or make money, then it can help to guide your decision making towards making a good purchase for your business. The payback period concept is not useful for some equipment purchases that have no obvious relationship to saving or making money. Also, you must be careful not to convince yourself that an equipment purchase will have a short payback period by not taking into account all the factors that should be entering into the decision (e.g.,storage costs, location of your business, availability of labor, interest rates on a larger purchase, competitors, etc..).

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