Equipment Appraisal Blog | Understanding Machinery Appraisals

Corporations maintain fixed asset records for property tax and financial reporting purposes. The value of all company assets (including real estate, equipment, and vehicles) is calculated using standard accounting procedures. However, this value – known as net book value – typically has no relation to the market value of those same assets. Business owners are often shocked to find that the net book value and market value of their assets are nowhere near each other.

What is Net Book Value?

When a company acquires an asset – such as a piece of real estate, a machine, or a vehicle – the purchase is recorded on the company’s fixed asset record. This record (which may have alternate names such as depreciation schedule or tax asset detail) captures the date and purchase price of each acquisition.

Corporations will then depreciate the purchase price over time, typically according to standard accounting procedures such as GAAP, or Generally Accepted Accounting Principles. The acquisition value minus the accumulated depreciation is the asset’s net book value.

There are multiple methods and timeframes for calculating depreciation. However, in all cases, after the entire accounting life of the asset has passed, the net book value is recorded at either a nominal salvage value, or simply and most commonly taken all the way down to $0.

In many jurisdictions, business personal property taxes are based on the depreciated asset values reported by the owner. Corporate accountants will therefore often select the shortest asset lives defensible in order to depreciate equipment purchases as quickly as possible.

How is Market Value Different from Net Book Value?

While the net book value of equipment is calculated according to common accounting procedures, market value is determined by real buyers and sellers in the equipment marketplace. Another way to think of the difference is this: net book value says, “How much is this asset worth for tax calculations?”, whereas market value says, “How much would somebody actually pay for this item?”

Market value is therefore not a mathematical calculation like net book value. Instead it is an opinion or estimate of potential transaction value. Net book value is determined by accountants, while market value is estimated by professional equipment appraisers.

Unlike net book value, market value cannot be calculated from a formula or depreciation schedule. It requires professional judgment supported by market evidence, comparable sales, cost analysis, and other valuation methodologies depending on the type of equipment.

Net book value is used primarily for tax accounting and financial reporting purposes. Market value estimates may be used for a wide range of purposes including collateral valuation, purchase price allocation for financial reporting, acquisition due diligence, insurance, and litigation.

Do Fair Market Value and Market Value Have the Same Meaning?

A market value is an estimate of what an asset may sell for in a specific circumstance. But there are many different types of market values, depending on the situation being considered. An equipment appraisal may include multiple types of market value, including fair market value, orderly liquidation value, forced liquidation value, or several other types.

The most common type of market value is “fair market value,” which is the price a willing buyer would pay a willing seller with neither party under any compulsion to make the transaction.

For example, when you buy a used car from a dealer, you are not compelled to buy the car – after all, there are many other car lots in town. Also, the dealer is not compelled to lower their price to entice you – they can wait for another interested buyer.

When you and the dealer have agreed to a price for the car which satisfies both of you, you may consider that a “fair” price, and that price would be a good indicator of fair market value.

However, there are other situations which result in market values which may not be considered “fair.” For example, in a bankruptcy auction, the seller is typically compelled to sell to the highest bidder by the court.

Besides the compulsion to transact, other circumstances such as marketing timeframes, buying terms, and relationships between the parties can also result in transactions which are not deemed to be “fair” in the sense of representing fair market value.

Appraisal organizations, such as the American Society of Appraisers, provide equipment in alternative situations.

Is Market Value Always Higher than Net Book Value?

An equipment appraisal estimates market value based on actual marketplace conditions rather than accounting depreciation, which is the basis of net book value. Because of this foundational difference, market value and net book value are rarely equal. For older equipment in particular, market value is typically higher than net book value.

It is not uncommon for companies in equipment-heavy industries, such as agriculture, construction, manufacturing, packaging, and processing, to own many long-lived equipment assets which have net book values of $0. But when these items are sold in the open marketplace, they often have positive market value.

A common example would be a semi tractor. Large trucks such as semi tractors are often assigned a 5-year accounting depreciation life on fixed asset records. A 10-year-old semi tractor with 1,000,000 miles would therefore often be assigned a net book value of $0. However, the actual resale value of such a tractor may be between $5,000-$25,000, depending on the model, condition, and configuration. In this case, market value is clearly higher than net book value.

However, market value is not always higher than net book value. For newer equipment in particular, market value may be lower than net book value.

A common example of this may be restaurant equipment. Food service furniture, fixtures, and equipment (FF&E) are often assigned a 7-year accounting depreciation life. If the restaurant owner’s accountant decides to use a simple straight-line depreciation method over 7 years of accounting life, the net book value of a 1-year-old fully-furnished commercial kitchen would have been depreciated about 15%.

However, the actual resale value of commercial restaurant equipment tends to fall very quickly, often as much as 25%-35% in the first year of service. Dining furniture, store fixtures, and point of sale systems may lose value even more quickly. In this case, market value is clearly lower than net book value.

Certified equipment appraisers can help business owners and accountants determine whether market value is expected to be higher or lower than net book value. Only rarely, and only by chance, would the two values be equal to one another.

Understanding the distinction between book value and market value is essential when financing equipment, preparing financial statements, negotiating an acquisition, settling litigation, or obtaining appropriate insurance coverage. An equipment appraisal helps ensure those decisions are based on actual market conditions rather than accounting conventions.

Commercial lenders such as banks, credit unions, and alternative financiers each may have unique approaches to risk tolerance and lending parameters. But they tend to look at industrial machinery and equipment through the same lens: “If this loan defaults, how much will I recover from this collateral?”

An independent equipment appraisal helps lenders understand collateral strength and liquidation risks.

The Commercial Lender’s Perspective

For borrowers, equipment is a contributing factor to business earnings. Business owners see each piece of equipment as a revenue-generating asset. This often causes a disconnect between lenders and borrowers, because lenders are not generally concerned with the value of individual assets in a going concern.

The reality is that at a high level, lenders are focused on two broad outcomes: either the borrower performs as agreed, or the lender will have to evaluate alternative recovery options.

In Situation 1, the market value of the business assets has limited relevance to the lender. Cash flow and payment performance take priority as long as the loan is current. Whether a particular machine is worth $1 or $100,000 is not particularly important.

In Situation 2, the lender may have to decide whether to renegotiate the loan or whether to liquidate their collateral.

In either situation, lenders focus on repayment and recovery outcomes rather than maximizing the operating value of the business itself. If a borrower defaults, the lender is generally not going to repossess and operate the business as a going concern. They are in the business of lending and finance, not business operation.

They are going to either restructure and work toward repayment, or they are going to cut their losses and liquidate the business.

Special Assets and Workout Departments

If a borrower defaults on their commercial loan, the loan often moves to a department of the bank called “special assets” or “workout.” (Special Assets refers to the lending team responsible for managing high-risk or distressed loans. Workout is the active process used to restructure a loan or recover collateral.)

In smaller banks where employees may wear multiple hats, the two terms are often used interchangeably to refer to the same concept: a loan that is in default. In these cases a lender’s mindset may shift; the loan is no longer a certain revenue-generating asset, but rather a puzzle which can only be solved with information, consideration, and thoughtful decisions.

The lender’s priorities are complex. They must balance minimizing risk, preserving community reputation, preserving borrower relationships, maximizing return potential, and minimizing legal battles, among other concerns.

When commercial machinery and equipment (M&E) collateral is involved, the first step for the lender is to understand the market value of the assets.

Realistic Outcomes for Machinery and Equipment Collateral

There are many ways to consider market value for business equipment.

• “How much would it cost me to replace these machines?” This is useful for insurance purposes.
• “How much life does this facility have left before major replacements are required?” This is useful for transactional due diligence.
• “Are all of these machines active and earning income for the business?” This is useful for Fair Value and financial reporting appraisals.
• “What would I get if the business closed and we sold these machines?”
• Fair Market Value estimates what the equipment may be worth if offered in a willing buyer, willing seller situation, and an extended period is allowed for resale.
• Orderly Liquidation Value estimates what the equipment may be worth if offered as-is, where-is, with a reasonable time allowed for liquidation, such as 3-6 months depending on the equipment type.
• Forced Liquidation Value estimates what the equipment may be worth if sold as-is, where-is, in a public auction or in a similar environment where buyers are assuming all risks and required to purchase immediately.
• A low M&E appraisal may encourage the lender to allow the business to continue operations as the most likely way to recoup some financial return. However, a low appraisal may also push the loan over a minimum debt-to-equity threshold which could send the borrower further into a special assets spiral.
• A high equipment appraisal may allow the borrower to claim more collateral than expected and restructure their loan favorably. However, a high appraisal may also convince the lender that an immediate liquidation will provide their easiest and best financial return.

But for a commercial lender, only one question is important:

The reality is that if a loan defaults, the lender is not often able to sell an entire facility as a going concern. In the majority of cases, the business is liquidated and the personal property, real property, and any other business assets are sold piecemeal in the open market.

The M&E can be sold under varying terms and timeframes, which create the different levels of value commonly used by lenders:

Because of the different levels of risk and timeframes involved, FMV tends to be the highest value, with OLV and FLV each lower. The differences between each value type can be very large or very slim depending on the equipment type and situation.

The M&E Appraiser’s Role

The lender cannot determine the most appropriate path forward for a distressed loan without understanding the likely outcomes of each alternative. Collateral value is only one input in that decision. Lenders must also weigh borrower cash flow, guarantees, customer concentration, management quality, and other factors that influence recovery outcomes.

The equipment appraiser’s role is to advise the lender of the likely results of an equipment liquidation, including risks, potential complications, and financial return.

The equipment appraiser does not always know how their assignment results will be utilized. Oftentimes borrowers will believe that a higher or lower value will help their cause, but the reality is more nuanced.

The appraiser must be unbiased and disinterested in the outcome. Their job is to provide professional opinions and informed context to their client; the commercial lender has the ultimate job of deciding how to utilize the appraisal results.

When appraising machinery and equipment, clients may believe that the estimated value translates to a sure bet that it will sell for that price. It is important that your report distinguish between the two concepts. There are variables, both known and unknown, that could play a part in the final sale outcome. An appraisal is an independent opinion based on sound research and does not guarantee the ultimate disposition price of the asset.

The appraised value of any piece of equipment is based on a combination of market and cost data, which looks at factors such as comparable sales and depreciated replacement cost. This is a solid foundation and provides an estimate of what the equipment is worth as of a specific effective date. The definition of value may be at a fair market or liquidation level, which will dictate a materially different resale market price level. If the appraisal is estimated at Fair Market Value and the seller places it in an auction, the price realized will be very different than the estimated value.

The condition of the equipment will impact both its worth and potential sale price. Proper maintenance and upgrades can maximize its value, while excessive wear and tear and outdated technology can bring it down. Most accredited equipment appraisers are not mechanics and assume the assets are in normal operating condition unless informed otherwise. Even when an appraiser adjusts value for a lesser condition, a buyer may believe there are significantly more repair costs involved to bring the machine into good operating condition.

For custom-built equipment, the resale market will be limited. An appraiser assumes the equipment will be sold to another user who will pay a fair price; however, finding the right buyer may take significantly longer, which will affect the price.

Buying and selling are often about psychology as much as they are about numbers. Buyers often want a deal or a sense that they are getting something special. This means the equipment might sell for less if there are concerns or doubts—even if it is technically worth more. How the sale is negotiated, the relationship between buyer and seller, and the urgency of either party can all affect the closing price.

Understanding that there may be a gap between an item's appraised value and what it might sell for is key to setting realistic expectations. Research the market, consider the timing, and prepare for negotiation. By doing this, you can find a fair middle ground that respects the equipment's worth, while also being competitive in the current market landscape.

Regardless of the state of the overall economy or particular industry, there is always a demand for machinery and equipment valuation work. It is essentially a recession-proof business. There are potential customers across various market sectors seeking experienced appraisers to assist with their transactional or dispute-resolution matters.

Here are a few examples of the more common client types:

Business Owners

Companies that use a lot of equipment in their day-to-day operations will look to buy used equipment to replace older assets that need to be sold in the secondary market. Appraisers can assist in both ends of these situations. Owners will also need valuation work when acquiring other businesses for tax and accounting purposes.

Financial Institutions (Collateral-Based Lending and Leasing)

Whether it’s a traditional bank looking to support a loan or a leasing company wanting to set realistic residual values and resell returned equipment, accredited machinery appraisers are involved in valuing on both the front and back ends of these deals.

Private Equity Groups

In the merger and acquisition (M&A) market, private equity will target investments in certain equipment-based companies. They make a long-term growth acquisition or a shorter-term buy-sell opportunity. Machinery appraisals are needed from a risk, accounting, and tax perspective.

Attorneys-Partner Dispute Work-Divorce-Insurance

For experienced appraisers with the right credentials, there are plenty of opportunities to team up with law firms on business disputes, divorce cases, insurance claims, or tax and accounting issues, and to get involved in litigation support work as an expert witness. This creates the ability to build up a resume of testimony experience as well.

Individual and Corporate Donors

Donation appraisals are quite common as businesses and individuals will give their used assets to technical schools, universities, museums, and other non-profits, requiring a qualified appraisal for items valued over $5,000.

In summary, this broad range of clientele affords machinery and equipment appraisers several avenues for effectively growing their businesses.

Developing a foundation to be an accredited M&E appraiser can come from many different career paths. Although some candidates start right out of college, having worked in another capacity in the machinery industry can have additional benefits.

Gaining experience as an asset manager in the equipment finance and leasing industry is a common profession that leads to independent valuation work. The credit risks associated with lending and investing need to be leveraged with the ability to better understand the value of the assets being collateralized. Properly estimating value throughout the deal term will lead to better upfront decision-making and future outcomes should the equipment be repossessed or returned in a default or end-of-lease scenario.

Later in their careers, asset managers may decide to work for independent valuation companies or accounting firms with appraisal divisions.

Another parallel career is used equipment sales and remarketing, either as an auctioneer or a machinery dealer specializing in certain industries such as heavy equipment, transportation, and manufacturing. Learning about the secondary market firsthand, where you see real-time used-equipment sales every day, is a great way to develop the skills necessary to become an independent M&E appraiser.

Equipment dealers sell in both retail and wholesale environments, which translates to fair market and orderly liquidation value comparisons. Auctioneers are typically buying and selling in a more distressed setting that lends itself to a forced liquidation value. Companies in these industries often develop databases of historical resale prices that can be used to accurately estimate the value of used equipment.

This is another area where certain individuals working for these companies might decide to focus on valuation more exclusively and strive to become an accredited ASA MTS appraiser.

Anyone working in businesses that have a heavy focus on machinery and equipment, either from a resale or operational perspective, will be able to use their skills to gain a leg up on becoming an independent appraiser. Professional appraisal work is a specialized skill that offers the opportunity to help clients in different scenarios that require an unbiased opinion of value, whether to close transactions or settle disputes.

Having the right background that establishes your credentials goes a long way to becoming a successful ASA MTS appraiser.