Equipment Appraisal Blog | Understanding Machinery Appraisals

Replacement Cost New, commonly abbreviated as RCN, is very important to understand and estimate with equipment appraisals. RCN represents the current cost of replacing an item with a new one of a similar kind, quality, and capacity. It provides a clear starting point benchmark for determining the value of equipment in cases where depreciation and obsolescence need to be factored in.

For example, with insurance claims, understanding the replacement cost new is critical because policies may cover the cost of replacing damaged or destroyed machinery with new equipment. Even with claims where depreciated replacement cost is the appropriate term, you need to begin with establishing a reasonable RCN.

In virtually every appraisal, RCN is the starting point for calculating the depreciation of equipment. Once RCN is determined, adjustments for physical, functional, technological, and economic obsolescence can be applied to arrive at Fair Market Value. RCN estimates can be developed directly from the market based on listed prices and quotes or annualized using industry data.

Estimating RCN can help businesses evaluate whether it is more economical to repair or replace equipment. If the cost to repair old equipment approaches or exceeds the RCN, a business may choose replacement over repair.

With investment analysis, companies will assess capital expenditures or plan equipment purchases. Understanding replacement cost new assists with budgeting accurately and comparing the financial viability of acquiring new versus used equipment.

For accounting purposes, such as financial and tax reporting, knowing the RCN can assist in determining the correct value of equipment for balance sheets, tax depreciation schedules, and other financial statements. Even if comparable market data is available to estimate the value of used equipment, it is important to understand RCN as a key variable within the cost approach to gain additional perspective and normalize the data found in the used resale market.

In summary, RCN serves as a foundational figure for analyzing and supporting the value of equipment and is essential in all aspects of appraisal work, in addition to informed financial and operational decision-making within other contexts.

Forced Liquidation Value (FLV) is a type of appraisal premise commonly used in equipment valuation, particularly when the sale of the machinery needs to happen quickly, often under distressed conditions. FLV typically reflects the price that equipment would sell for under less-than-ideal conditions, such as a short sale period, limited buyer interest, or an auction. A typical time frame to complete a sale would be 60-90 days.

Here are some situations when using FLV in equipment appraisal may be appropriate:

Bankruptcy or Foreclosure

When a company is going through bankruptcy or foreclosure, assets may need to be sold fast to pay off creditors. In these cases, FLV provides a realistic estimate of what the equipment might sell for under the pressure of time.

Loan Defaults and Distressed Sales

If a borrower defaults on a loan, the lender might repossess the equipment and sell it to recover losses. FLV is used because the sale is usually time-sensitive, and the market conditions may not be favorable. When an organization needs to sell its assets quickly due to financial difficulties or liquidation, FLV is estimated to reflect the urgency and the likely lower price that will be realized under such conditions.

Asset-Based Lending

In asset-based lending, where equipment serves as collateral, the lender may use the FLV to calculate the amount of the loan, since, in case of default, the equipment might have to be sold quickly.

Auctions

When equipment is sold at an auction, particularly in distressed situations, FLV is relevant because the assets are sold all over a 1–2-day period, with a short window to advertise the sale. The bidding process might very well result in lower prices compared to private sale conditions.

Business Closure or Downsizing

When a business is closing down or downsizing and needs to sell off equipment immediately, FLV is used to estimate the expected return in a forced sale situation.

In summary, FLV is most appropriate when an immediate liquidation is expected, and these circumstances prevent a seller from marketing over an extended period to get the best possible price.

One of the benefits of choosing to become an accredited equipment valuation professional is the diversified range of clientele who need these services. Regardless of the state of the overall economy or particular industry, there are potential customers that come from several different market sectors looking for experienced appraisers to assist them with their transactional or case-related deals.

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

Business Owners

Companies that utilize a lot of equipment in their day-to-day operations commonly look to buy used equipment to replace older assets that need to be sold in the secondary market. Appraisers can assist in both of these situations.

Banks and Leasing Companies

Whether a traditional bank is looking to collateralize a loan or a leasing company wants to set realistic residual values and resell returned equipment, accredited machinery appraisers can help value both the front and back end of these deals.

Private Equity Groups

In the merger and acquisition markets, these groups will look to invest in certain equipment-based companies by acquiring them, reorganizing them, and maximizing their profitability over a short-term period. Eventually, they will resell the business within the respective industry. Machinery appraisals are needed from a risk, accounting, and tax perspective.

Attorneys-Partner Dispute Work-Divorce-Insurance

For experienced appraisers with the right credentials, teaming up with law firms on internal and external business disputes, divorce cases, insurance claims, tax issues, and related areas offers plenty of opportunities to get involved with litigation work. This allows one to build up a resume of testimony experience as well.

Individual Donors

Donation appraisals are quite common. People 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 to grow their business effectively. Think about the types of clients that would best serve your business.

Developing the foundation to becoming an independent equipment appraiser can come from many different career paths. It can be beneficial to work in another capacity before gaining accreditation in this lesser-known valuation discipline. My background began in equipment finance, leasing, and the asset management side of that business.

When people hear the term asset management, they may first think of the financial investment “money” side of the practice. However, for the past 40+ years, it has become a significant component of every equipment lending business as well.

The risk profile associated with every machinery and equipment loan or lease needs to be leveraged with the internal ability to understand better the value of the assets being collateralized by these investments. A potential exit strategy must also be put in place should the equipment be repossessed in a default situation or returned at the end of a lease expiration.

In the early days of equipment asset management, most finance companies relied on working with equipment brokers and auctioneers who managed their returned equipment and facilitated the sale of these assets under a liquidation scenario. This often resulted in exceptionally low returns to the lender, who then faced absorbing losses from their initial investments.

Working with these equipment dealers over time became an educational experience for internal asset managers, who learned how to better estimate current and future equipment values and how best to resell returned equipment for higher prices.

Over time, many of these equipment lenders, banks, and leasing companies sought out experienced appraisers and certain industry experts to work more directly with them to minimize future investment risk and maximize the return on their used equipment sales.

In many cases, they eventually hired them full-time to manage their portfolios while working closely with the rest of the investment team on a day-to-day basis to create a synergized relationship with the rest of the operation.

It is common today to see accredited appraisers working internally for many larger banks and leasing companies. Having their asset managers educated and experienced in independently appraising machinery and equipment creates the best risk profile for the financial services business, and it allows for the opportunity to maximize the resale value of their returned equipment portfolio.

Being accredited equipment appraisers affords us the opportunity to be aware of the overarching transactions that our valuation work is tied to. In many cases, it is a straightforward buy/sell scenario in which our client is looking to resell used machinery that has become excess to their operation or is being upgraded with newer models.

Most times, our customers request we estimate Fair Market Value, which is the gold standard definition of value when looking at an arm’s length transaction where both the seller and buyer are on an even footing. This level of value is ideal from the seller’s perspective, given that they can expect to receive the best price for their equipment. However, there may be factors involved that will create a different situation.

For example, the owners may not normally be in the business of remarketing used equipment and need to turn to machinery brokers or dealers to facilitate a sale. Banks and leasing companies that recover their equipment and need to resell their assets would also fall into this category.

Time can also be a factor that plays into the equation. Some resellers would prefer to cash out of their used equipment sooner than later, which will result in a level of compulsion on their behalf that will ultimately affect the sale price.

In these situations, the seller needs to understand what a reasonable range of value is so they can be realistic with expectations when entering the unfamiliar scenario of reselling their used equipment.

Appraisers can greatly assist with developing this range as they can suggest to the client that they include both an Orderly and Forced Liquidation Value along with the Fair Market estimate.

Having two or three different value premises to consider instead of one will provide realistic expectations depending upon the situation the seller finds themselves in. If they would rather avoid being directly involved in the resale effort altogether, they might consider placing their assets in an auction, which would be more in line with forced liquidation. Or if they end up selling directly to a used equipment dealer, they may look to realize an orderly liquidation value level.

Whatever situation you find yourself in when needing to resell used equipment, consider looking at a range of values, which can be accomplished by speaking with an experienced appraiser who understands the differences and can help steer you in the right direction.