Equipment Appraisal Blog | Understanding Machinery Appraisals

As appraisers, we are at times asked to estimate orderly liquidation value on a "net" basis, which adds an anticipated cost or expense element to the conclusion. These requests most frequently come from banks and other financial institutions that are not in the business of buying and selling equipment. Their goal is to make a sound credit decision, based in part on a collateral review for a loan or lease, while including a more conservative worst-case scenario, where they would need to recover the equipment and sell it at a future point in time. This might occur in a customer default and repossession situation, bankruptcy, or an end-of-lease return scenario.

For a refresher, here is the formal definition of Orderly Liquidation Value from the American Society of Appraisers (ASA):

Orderly Liquidation Value is an opinion of the gross amount, expressed in terms of money, that typically could be realized from a liquidation sale, given a reasonable period of time to find a purchaser (or purchasers), with the seller being compelled to sell on an as-is, where-is basis, as of a specific date.

This estimate is considered a "gross" amount, meaning that it excludes any associated costs of sale that may occur during the period leading up to and associated with the transaction. This is where the "net" component comes into play.

Net Orderly Liquidation Value will consider common expenses associated with a sale. These could include recovery costs such as dismantling, rigging, and shipping; short-term storage; marketing/advertising; and broker fees/commissions. Depending on each specific scenario, these expenses will vary, and some may or may not be applicable. For instance, the size and type of equipment and whether you can keep the machinery at its present location during the marketing period, are large factors pertaining to the removal costs. Leasing companies will often require their customers to return the equipment at their expense during the end of lease stages, while alternatively, in bankruptcy, the bank may need to arrange and pay for this themselves.

To that end, the appraiser will subjectively make reasonable assumptions as to what the average costs may be, in a hypothetical situation, based on their experience. They may determine the focus should be on storage and selling costs, which are more consistent and likely to occur in any situation. Either way, estimating net orderly liquidation value first requires a determination of the gross value, and then applying a reasonable percentage or dollar reduction to that figure, in order to arrive at a final conclusion. Some of the third-party sources relied upon in the normal course of the appraisal can likely assist the appraiser with this calculation.

Even though other professional appraisers may disagree with me on this topic, I find it is relevant to raise the issue of whether the income approach should apply or even be a consideration when valuing most machinery and equipment (M&E). In my 40 years of working in the M&E asset management and valuation markets, involving machinery across virtually every known industry, I can count on one hand how many times I have even attempted to assess and place weight on this approach. The same goes for the number of times I have been asked by a client even to consider it.

In layman's terms, the Income Approach estimates the current value of the future economic benefits of owning a particular piece of equipment. Similar to using this approach to estimate the value of a complete business or real property (land, buildings, and related assets), which is relevant in many cases, it requires the ability to clearly separate and directly apply revenue and expenses to M&E.

A scenario where this might be possible is a business that owns a rental fleet of equipment such as trucks, trailers, or heavy machinery. Both short- and long-term rental history could be considered and potentially applied to estimate the value of this type of activity. There are concerns, however, as to the validity and reliance of the assessment.

First, it is common practice in the equipment rental industry to apply discounts to the eventual purchase price of these assets based on past rentals when their clients eventually want to buy them outright. Even with large assets such as aircraft, this is not unusual. The result is that a significant portion of rental income lessens the real market value of the equipment, causing it to get tangled up with the other approaches to value.

Second, assuming you can estimate value under the Income Approach, given the restrictions and requirements, how do you weigh the result in the context of the other approaches, namely Cost and Sales Comparison (Market)?

You cannot completely ignore the other two approaches, as they should be considered and applied to some degree in every equipment appraisal regardless of the purpose, especially if the income approach estimate is materially different from that of the cost and market methodologies. I have never completed an M&E valuation without placing weight on each of these two methods.

In summary, these are just two of several issues that create concerns about the appropriateness of utilizing the income approach to assess M&E value. Contact an accredited professional appraiser to learn more on the topic.

When an appraiser estimates value, they must do so under an assumed premise that relates to the type of transaction being undertaken and the potential outcomes of an impending sale. Premise of value is one of the most critical components of an equipment appraisal given the different assumptions each premise represents and their material differences.

Each value premise must be defined in the appraisal and can reasonably be tied to a typical market transaction, such as a user-to-user sale or an auction liquidation. The most commonly referred to premise is Fair Market Value, which is utilized in many standard business agreements when the need arises to assess value for any purpose. The American Society of Appraisers defines Fair Market Value as follows:

Fair Market Value is an opinion expressed in terms of money, at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts, as of a specific date.

There are variations to the Fair Market Value premise, including assumptions for installation and continued use, which typically drive higher levels of value given the additional considerations involved. The important factor to understand with Fair Market Value is that it represents the most equitable transaction for both parties, where neither the buyer nor seller have an advantage. Each party is equally willing to transact and knowledgeable of all the facts.

In the open resale marketplace, this may not always be the case, therefore, other premises of value are considered, including Orderly and Forced Liquidation. These definitions add the factor of compulsion on behalf of the seller, with more limited time to sell a key factor. These premises are appropriate to consider with an inexperienced owner or if a company goes out of business. There may be a reduced level of control over the sale by utilizing a third party, such as an auctioneer, to liquidate the assets. This is the foundation for Forced Liquidation Value.

Liquidation premises of value are commonly reviewed by banks and other lenders who want to consider the possibility of having to step in and resell the equipment if their borrower defaults and they end up taking possession of the assets. They are not in the business of buying and selling machinery and may involve an equipment dealer or auction company to manage the logistics of a resale effort.

These liquidation premises will obviously drive a lower estimated value for the machinery & equipment. How much lower will depend on the type of equipment and the state of the resale market, among other factors. Consult with an appraiser to better understand these differences.

Many businesses rely on the use of heavy equipment to produce the products and services they sell, such as earthmoving, truck transportation, building construction, and all types of utilities, energy, and manufacturing companies.

In certain instances, the value of the machinery is the most significant component of the balance sheet, and can even be greater than the annual revenue of the business. If you own or are considering investing in a company with this type of profile, understanding the current market value of these underlying assets is as important as reviewing historic and forecasted financial statements.

To effectively measure the overall value of a business, one should consider breaking it down by the prominent asset types, both tangible and intangible, which translates to the need for an independent appraisal for each of these areas.

It would be careless to rely on the company's internal accounting records and policies to measure the value of their machinery & equipment, as they generally utilize accelerated depreciation rates to amortize the capitalized cost as quickly as possible.

If the company has a high content of expensive, long-lived machinery & equipment with an average age of over 5 years, there is every chance that the market value of these assets is much higher than the net book value recorded by their accountants. This variance can be monumental, even for small businesses with lesser sales volume.

For example, a company with $20,000,000 of capitalized machinery and equipment could effectively depreciate the entire cost over 5 years, realizing a net book value of $0 after 60 months. If these assets are used in manufacturing or construction, the likelihood is they will have a normal useful life range between 10-20 years, as long as they are well maintained.

Based on this generic scenario, it’s not unreasonable to estimate the market value of these assets to be $10,000,000 or higher, if the equipment is still relatively young, and in good operating condition. The appraised value of the company’s equipment would then be utilized as a part of the overall business valuation, instead of $0. One might say that is a difference worth determining!

Whether your targeted company is heavily reliant on tangible machinery equipment or not, it is always a prudent decision to obtain an updated Fair Market Value appraisal for these assets to effectively measure their true worth

Image source: Aqua Mechanical on Flickr license

I have heard and used this phrase many times over the years when people are discussing the topic of quality vs. price in both everyday life and business. It is a commonplace belief that the more you pay for something, the better the product or service will be. While there are always exceptions to this axiom, where services are concerned, the fact is that higher quality costs more since it requires experience, integrity, and expertise.

I have personally learned this to be true from my experiences working with sub-contractors, landscapers, tree care companies, accountants, attorneys, even my personal and pet groomers. From a consumer product perspective, it is more of a challenge to compare price vs. quality, given the broader competitive marketplace. There are many reliable, less expensive options out there, however, you should still consider paying a bit more to get the best quality for your hard-earned cash.

The bottom line is twofold:

Make the decision ahead of time that you want the best there is to offer and; research potential candidates to fully flesh out who can deliver as promised.

As machinery & equipment appraisers with decades of experience and the best accreditation the industry provides, we know the cost to engage with us will not be the least expensive option when you are in need of valuation services. We lose out on some opportunities every day because our cost structure will never compete on price with less experienced appraisers who lack the credentials and ability to provide a quality service and product which, ultimately, will be deemed unreliable to both you and any third parties involved in the transaction.

In all markets and industries, both personal and business, these high-to-low-end service options are available to everyone.

In the valuation industry, the “get what you pay for” difference revolves around working with a machinery & equipment appraisal firm that is extremely responsive from beginning to end, and becomes a partner who best understands your goals in the overarching problem being solved. From the scope of work discussion to engagement, to report delivery and consulting, these products and services are of unparalleled quality when compared with any other option out there.

Once you have determined this type of relationship is the one you want to be involved with, please reach out and let us know what we can do for you.