You may have a piece of equipment that is in good working order, yet be shocked to hear that a machine appraiser tells you the equipment is obsolete in economic terms. To understand and act upon a machinery appraisal, you must have working knowledge of the concept of economic obsolescence. Let us explain it for you.
What is Economic Obsolescence?
The American Society of Appraisers notesthat economic obsolescence is a difficult factor to explain. It refers to a situation where a piece of equipment loses either its usefulness or its value for factors unrelated to the object itself.
For example, a typewriter was highly useful until computers came along. The typewriter became obsolete once computers displaced typewriters in the majority of offices.
Odds are, if you are a niche retailer, you have specialized equipment in your business that is or will become obsolete.
A machinery valuation can help you determine whether to repair or replace outmoded equipment, help you conserve business profits, and show you where you should invest additional capital.
An appraiser performing a machinery valuation will examine the item, determine whether economic obsolescence is occurring, and identify the factor or factors that are causing it. Finally, an appraiser will provide research materials to support their appraisal and go through the results of the valuation with you.
You will have a good understanding of your equipment value at the end of the process. As a result, you can make informed decisions about business growth.
Factors Affecting Economic Obsolescence
An equipment appraiser will review a broad range of factors when appraising a piece of machinery. During the equipment appraisal, the appraiser may notice one or more factors that could suggest obsolescence. These include:
- Increased cost in materials and supplies related to usage of the equipment
- Reduced demand for products made utilizing the machinery
- Changing governmental or environmental regulations that affect the use of the equipment
- Over supply of product in the marketplace
Any these factors reduce the profitability of the product and viability of the equipment. When the equipment is no longer cost effective, or the market does not require the products made with the equipment, it can become obsolete.
If there is a better opportunity to invest staff time or money, the conditions may be right for economic obsolescence.
While appraisers agree on the circumstances that might suggest obsolescence, they disagree on when the condition is actually present. The concept is highly subjective, so one appraiser may see decreased demand as a blip in the market while another may perceive it as the new reality going forward. Machine appraisers can use several methods to quantify the degrees of obsolescence, including gross margin analysis, inutility, supply and demand analysis, industry return on capital or equity, market-derived approach, and income or earnings shortfall examination.
The subjective nature of the concept can make it difficult for business owners to accept a machinery valuation or take the appraiser's word that equipment may in fact be obsolete.
Before winging it, take the time to talk with the appraiser and make sure they have the necessary knowledge. When you select a professional who knows your business model, you will feel more comfortable with their judgment and all equipment valuations.