Equipment Appraisal Blog | Understanding Machinery Appraisals

Elements of Equipment Appraisals: Approaches to Value

Posted by Equipment Appraisal Services on Mon, Jul 10, 2023 @ 07:30 AM

Machinery and Equipment Appraisal Approaches to Value

As an accredited or certified machinery and equipment appraiser, you will learn that three approaches to value are considered for every appraisal: The Sales Comparison, Cost, and Income Approaches. Except in rare cases, only the first two are utilized in a typical valuation as business revenue and expenses under an income approach are very difficult and impractical to apply directly to equipment as part of a larger operating facility. Here are a few broad discussion points regarding these two primary approaches.

The Sales Comparison Approach, which is commonly referred to as the “market” approach, focuses on the research and analysis of similar used machinery being bought and sold in the resale marketplace. The appraiser reviews available listings, sales, and databases, while gathering opinions of value from dealers and other resellers, and ultimately adjusts the data to reflect a reasonable opinion of value based on the specific characteristics of the assets being appraised.

The Cost Approach relies on the determination of key variables that pertain to estimating equipment value, including replacement cost new, useful life, effective age, and annual levels of depreciation. Understanding how these factors work in conjunction with each other, as well as providing additional perspective to complement the sales comparison approach, will create a balanced opinion of value.

Both approaches should be considered and relied upon to a certain extent in every equipment appraisal to avoid a limited perspective. The amount of data the appraiser can develop under each approach will determine the level of weight assigned to each. In some cases, the equipment may have a limited amount of used market data and need stronger reliance on a cost approach and vice versa.

It is important to understand where the most reliable sources of data are found under each approach and how to reasonably interpret them. The valuation professional should look to specific market and industry sources that directly relate to the subject assets being valued. The appraiser should also avoid taking every source at 100% face value while creating a “common sense” approach that brings the information together to form a realistic opinion of value.

Keep in mind the conclusions you ultimately estimate are your opinion, and not anyone else’s. You will cite all the sources you relied upon; however, they are individually only one component of the overall appraisal that you develop. The more experience you gain over time will bring these processes into better focus as you continue to understand the nuances of machinery and equipment valuation.

Tags: cost approach, accredited appraisers, Approaches, sales comparison approach, Income Approach

The Income Approach & Equipment Appraisals. Are They Ever Compatible?

Posted by Equipment Appraisal Services on Mon, Jan 23, 2023 @ 07:30 AM

Machinery Equipment Appraisals Valuation Income Approach

Machinery and Equipment is perhaps the least understood type of property when it comes to appraisal approaches when compared with Real Estate and Business Valuation. This may be because, in large part, real property, such as buildings, land, and improvements, are commonly viewed as higher value, non-depreciating assets, while overall business appraisal considers the sum of everything a company has to offer in an investment or lending scenario.

When considering the three industry-accepted appraisal methods, Cost, Sales Comparison (Market), and Income approaches, machinery valuation will almost exclusively rely on the first two, while real estate and businesses commonly use the income approach as well.

There are a couple of primary reasons why this is the case. Historic and discounted future cash flows considered and utilized under the Income Approach can often be directly tied and measured with buildings and land in the form of rental and lease revenue, while a business appraisal is in large part determined by the internal financial performance of the company.

Machinery, along with other types of personal property, are considered support assets required to be utilized as a part of a larger working operation. Therefore it is impossible and impractical to try and allocate a portion of any type of business revenue to the equipment itself. Even if machinery is the primary asset involved with the business, there are many other factors to consider in the overall company performance which directly or indirectly drive revenue. To try and allocate all or a part of these cash flows to it would be unfeasible.

Equipment value can be directly measured under the cost and market approaches by researching what new and used equipment sells for in the marketplace while applying reasonable factors for normal useful life and annual levels of depreciation. Regardless of how often the machinery operates or how integral it is to the day-to-day operation of the business, the value of these types of assets is driven by what an unrelated third party would consider paying for them, whether in its current operation or for another future use. What it costs to purchase and install these assets, new or used, in the marketplace, along with a review of maintenance history and current condition, are the driving variables behind what someone would pay for them, which ultimately translates to value.

If you are going to attempt to use the income approach to appraise equipment, make sure you have solid evidence that the cash flows are directly related to the machinery itself, and ensure that you are basing the analysis under a “highest and best use” perspective which takes into account the asset’s full potential to generate revenue. The income approach has its place in the appraisal industry, and in many cases with businesses and real estate, will be a primary factor in determining what they’re worth, however, for machinery, equipment, and other types of personal property, as a general rule, stick to the cost and market approaches to measuring these assets' true value.

Tags: cost approach, Machinery & Equipment Appraisals, Approaches, sales comparison approach, Income Approach

Machinery & Equipment Appraisals - The Market is Everything

Posted by Equipment Appraisal Services on Mon, Jun 28, 2021 @ 08:00 AM

Machinery Equipment Appraiser Sales Comparison Cost Approach

For machinery & equipment (M&E) appraisers, there are basically two approaches to value that are ultimately relied upon when completing valuations: the Sales Comparison Approach and the Cost Approach.

Here is a brief description of each:

The Sales Comparison Approach

The Sales Comparison Approach indicates value by analyzing recent sales (or offering prices) of properties that are similar (i.e., comparable) to the subject property. If the comparable data is not identical to the properties being appraised, the selling prices of the comparable items are adjusted to equate them to the characteristics of the properties being appraised.

The reliability of this technique is dependent upon the degree of comparability of each property with the property under appraisal; the time of the sale; the verification of the sale data; and the absence of unusual conditions affecting the sale. This approach focuses on the actions of actual buyers and sellers.

The Cost Approach

The logic behind the Cost Approach is the Principle of Substitution: a prudent buyer will not pay more for a property than the cost of acquiring a substitute property of an equivalent utility.

Using the Cost Approach, the appraiser starts with the current Replacement Cost New of the property being appraised and then deducts for the loss in value caused by physical deterioration, functional obsolescence, and economic obsolescence.

The third approach to value, the Income Approach, is rarely used for M&E appraisals, and I will leave that discussion for another time. The Sales Comparison Approach is also commonly referred to as the “Market Approach”, however, don’t let that trick you into thinking the only time you rely on market data is under this approach. To effectively use the Cost Approach, an appraiser should rely on the marketplace as well, to estimate the variables involved with this approach, including replacement cost new, useful life, depreciation, and salvage value.

Perspective From Both Approaches

Every appraiser has their own process as to how they ultimately utilize the tools available to determine value. It is ultimately an independent, unbiased, subjective opinion, based on the gathering of a reasonable amount of data, which is developed during a research and analysis process.

To that end, from my experience, I have found it beneficial to take components from both approaches, established directly from the marketplace, and create a dual perspective that ultimately forms credibility checks to both, and provides the appraiser with supportable conclusions. Given that comparable sales data can tend to be inconsistent from machine to machine, even from the same sources, this blended approach can create a way to make sense of all the data points and better understand how particular assets should depreciate in the marketplace under normal maintenance and wear and tear guidelines. The use of the Cost Approach in any other way, such as using straight-line depreciation to cover all forms, or trying to develop credible levels of replacement cost and obsolescence by using broad industry data, is simply not reliable or supportable.

In summary, regardless of how much weight an equipment appraiser places on either of these two approaches during a valuation analysis, they should assure their clients that the data collected comes directly from the marketplace. The independent sources that an accredited M&E appraiser can find for virtually any type of asset are out there and available, they just need to do a bit of digging to find them

Tags: equipment appraiser, cost approach, Machinery & Equipment Appraisals, sales comparison approach

What is the principle of substitution in machinery appraisal?

Posted by Equipment Appraisal Services on Tue, Feb 09, 2016 @ 07:30 AM


The concept of the principle of substitution comes up any time that machinery and equipment appraisal is discussed. It is important that you understand what this concept means if you are seeking equipment appraisers for a machinery valuation. Learn what is the principle of substitution and what it means for both buyers and sellers of machinery and equipment. 

What is the principle of substitution?

In equipment value terms, the principle of substitution means that a party will not pay more for the piece of equipment in question than the cost they would pay for an equivalent piece of equipment with the same purpose.

For example, consider a tractor that is 10 years old and has an asking price of $5,000. If you can purchase a comparable tractor that is also 10 years old, yet costs just $4,000, why would you pay the extra $1,000 for the first tractor? Under the principle of substitution, the maximum acceptable buyer's out of pocket cost for the tractor would thus be $4,000. 

The principle of substitution is also affected by market demand. If hundreds of used tractors become available near you, sellers will have to lower their prices to attract buyers. If used tractors are scarce, sellers can raise prices above the equipment value if there is demand from buyers for the piece of machinery. 

The principle of substitution is a fundamental basis of the cost approach to machinery valuation. In the cost approach, an equipment appraiser usually determines the replacement cost of a new item (i.e., a new tractor) and then factors in lost value from age, wear and tear, and other variables to arrive at the equipment value in real terms. 

Why the principle of substitution matters in a machinery valuation

If you are in the market for a new piece of equipment, it is only natural that you would want the highest value for your budget, whether buying a used tractor or a new piece of factory machinery. Knowing the cost value of a piece of machinery can help you determine whether it is a good use of your funds. 

Even after the sale, the principle of substitution can be used to help insure the piece of equipment. Were your asset to be stolen or damaged, an insurer would not pay you more to replace the item than it was worth. Insurance agents will thus use the principle of substitution to calculate the amount to which you would be entitled in case of loss. In some cases, an insurer might send a machine appraiser to estimate your equipment's value before issuing an insurance policy. 

Likewise, businesses often need the appraised equipment values for tax purposes. Investing in something as important as a tractor is certainly a business write-off; to claim that it is worth the stated amount, you may need an equipment appraisal that is accurate and irrefutable in case of audit. 

Whether you are buying a piece of equipment or selling one, knowing the equipment value ahead of time can help you determine a fair price for the item. This can help equipment buyers move forward with the deal with confidence and assist sellers in pricing the item fairly enough to move it quickly. Equipment Appraisal Services offers machinery and equipment appraisals nationwide. Get peace of mind before you buy or sell your next asset by seeking an independent machinery valuation from our certified appraisers.

Tags: replacement cost new, principle of substitution, cost approach