Equipment Appraisal Blog | Understanding Machinery Appraisals

Whether you’re a business owner, investor, bank, leasing company, partner, key employee, insurance provider, or just someone buying, selling, or donating equipment, there are several instances where understanding value will greatly assist you. Quite often, however, the fees associated with business and equipment appraisals get in the way of making a sound decision; however, when compared with the benefits you gain, you should not hesitate to pull the trigger.

Generally speaking, appraisal services are designed to assist in facilitating the closing of a transaction, whether business or personal, and are also utilized in the settlement of disputes. These can come in many forms:

Bank Financing and Leasing

The traditional process of working with banks, leasing companies, and similar financial institutions will require a review of underlying assets in order to collateralize and secure a loan or lease. They also become critical in the event of a default or end-of-lease buyout. Whether you’re the lender or borrower, it’s a “no-brainer” to obtain an independent, qualified valuation of the business and related collateral.

Private Equity Investment

A secondary source of capital for small businesses or in an outright acquisition, private investment will allow companies to expand their resources, promote growth, or transfer ownership. Both the buy and sell sides of these transactions need to support their opinions of value with an accredited appraisal.

Buying and Selling

In any outright purchase or sale of virtually anything valuable, those involved will want to have a formal appraisal report on hand to confirm the fairness of the deal. Successful negotiations are the cornerstone of good business practice. A third-party valuation will assist in the process.

Settling a Partner Buyout or a Divorce

Partners in life and in business may eventually fall out of favor with one another, and separation becomes inevitable. Negotiating a fair settlement will be made clearer with an updated valuation.

Reporting Requirements

Whether it’s for accounting, tax, or insurance purposes, an unbiased appraisal will not only come in handy but may be a requirement of the underlying authorities reviewing the transactions. Many of these relate to independent valuation and review.

In summary, once you determine the importance of valuation and how it will facilitate the process of managing and closing any transaction, don’t hesitate to find the most qualified, experienced appraisers and make the investment. It will not only assist you today but will come in handy down the road when a similar situation arises.

Equipment appraisals rely on having accurate asset data; however, there will be situations where an appraiser must work with incomplete or uncertain information. In such cases, extraordinary assumptions can be used to move the process forward. Understanding when and how to use and disclose them is vital to producing a credible report, compliant with the Uniform Standards of Professional Appraisal Practice (USPAP).

According to USPAP, an extraordinary assumption is defined as “an assumption, directly related to a specific assignment, which, if found to be false, could alter the appraiser’s opinions or conclusions.” These assumptions are typically declared when they are needed to fill in certain gaps in asset data that are unknown or undocumented.

For example: The appraiser is unable to inspect certain machinery, and the client cannot provide sufficient specifications such as model numbers, years of manufacture, hours, or mileage. Disclosing an extraordinary assumption allows the appraiser to proceed based on what is believed to be true.

Another scenario would be if the equipment is decommissioned or in storage, the appraiser may need to assume it is still in normal operating condition to estimate value based on comparable functioning assets.

Using extraordinary assumptions helps the appraiser complete an assignment under real-world limitations. Properly applied, these assumptions will maintain transparency, alert the reader to potential limitations in the opinion of value, and ensure the appraisal complies with USPAP standards.

An accredited valuation expert with extensive experience in the valuation industry and who is familiar with many different types of machinery and equipment can often rely upon past assignments and sound judgement to reasonably make these types of assumptions. It is important to obtain as much historical background perspective as possible from the owner or operator of the assets to develop a comfort level that the assumptions being made are logical.

In summary, extraordinary assumptions are a practical tool in equipment appraisal, but they must be used with care and professional judgment. When information is uncertain or unobtainable, these assumptions allow the appraisal to continue, provided it is made clear what is being assumed and why. Ultimately, it is about balancing practicality with responsibility.

A fundamental valuation method used in equipment appraisal is the cost approach. It determines the value of equipment by considering the cost of replacing it with a similar item, adjusted for depreciation and obsolescence. There are several reasons why this approach is so important.

The cost approach offers a reasonable way to estimate value that can be relied upon by itself or as a complement to the sales comparison approach, depending on the level of market comps available to consider. It relies on tangible factors like replacement cost new, depreciation, useful life, effective age, and salvage value.

Look to establish these variables directly from the market based on available databases and third-party opinions, along with your own experience in developing and understanding the average annual loss in value from previous appraisal work. Avoid using a straight-line approach to depreciation, as it is not the way equipment actually loses value in the market or is determined in a potential resale scenario.

For businesses, knowing what it would cost to replace their used equipment with brand-new models is critical. The cost approach answers this question, providing a practical perspective for budgeting, insurance claims, and financial planning.

Many types of machinery, particularly those tailored for specific industries, lack an active secondary market. The cost approach ensures that even highly specialized equipment is valued accurately, considering its current utility along with the key variables that make up the cost approach.

While the sales comparison approach is often relied upon in equipment appraisal work, data in the external markets can often be inconsistent and misleading, with sales prices all over the place. The cost approach will assist in normalizing the data by focusing on the intrinsic value of the assets and creating a solid presentation of how machinery should resell over time as it continues to operate.

For companies with significant capital investments in equipment, utilizing the cost approach in this manner provides a reliable basis for assessing the worth of their assets. This is essential for decisions like mergers, acquisitions, investor buy-ins, and refinancing.

In summary, the cost approach offers a clear and grounded way to value equipment, ensuring that appraisals are accurate, fair, and reflective of an asset’s true worth. For businesses and appraisers alike, it’s a vital tool in navigating the complexities of equipment valuation.

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.

We have all seen or heard about the recent economic trends which have led to significant reductions to interest rates across broad spectrums of the consumer and business markets. The thought has likely crossed your mind to take advantage of these low rates when considering new equipment and personal property investments.

What about the existing capitalized assets you have owned for a few years and continue to work every day for your business? It might be time to look at refinancing options and take advantage of these low-interest rates before the markets start turning in the opposite direction.

Refinancing has several advantages to business owners who have considerable amounts of owned machinery & equipment. The two most significant are (a) the potential to lower your monthly debt payments where you have existing higher rate loans, and (b) the ability to access working capital based on the equity in your assets.

It is important to review your current debt structure and determine if existing loans can be restructured without a significant pre-payment penalty. Working with your present financial institutions should be a primary choice as they can often pre-approve your credit-based upon past transactions, and waive any penalties, provided you keep your business with them. Typically, pre-payment penalties expire after a couple of years, however, so be sure to read your loan contracts to better understand the terms and conditions.

The equity in your machinery &apm; equipment can be tapped if you have no or low debt obligations, and the cash can be used to inject working capital into your business, which then can be used for any number of new projects or growth plans. These assets have been capitalized and depreciated significantly on your books, however, their actual market value will likely be much higher.

To take advantage of this equity and support your assets’ current value, you should consider engaging an accredited, experienced machinery & equipment appraiser, who will complete a desktop or on-site valuation of your company’s tangible property. The appraiser will facilitate the process for you and suggest certain options that make the most sense in the context of your particular business and overall goals.

If you believe now is finally the time to start taking advantage of these favorable market conditions and low-interest rates, start taking these steps to make your financing plans a reality.