Equipment Value: Why is it Important For Small Businesses to Keep Current?
December 5, 2019 | Last Updated on: July 21, 2022
December 5, 2019 | Last Updated on: July 21, 2022
All equipment has a limit to its useful life. Typically, at the end of its use of life, there will be some sort of salvage value. A company’s financial statements should include the value of every aspect of the business. Construction equipment, office equipment, heavy equipment & even real estate are assets to a business that have a useful life and if taken care of properly, depreciate at a lesser rate and have a high book value compared to other similar pieces of equipment.
As a business looks to upgrade equipment, knowing the value of what they own can give owners a clear idea of the depreciation expenses they have (for tax purposes) and knowing the value can help with solving cash flow concerns if they look to sell a piece of equipment. There are several methods that can be used. A small business owner can use their own method independently by using an equipment value calculator, which will give the owner a strong idea of how your equipment may be appraised. Another avenue, which does come with a fee, is a more in-depth calculation that could be done with a certified appraiser.
Before dissecting the simplest way to calculate equipment value, it’s first important to understand why a business should know what it’s equipment’s value is. Whether it is looking for collateral for an SBA Loan, being involved in litigation, creating a buy-sell agreement, a business might be taking on a partner, or a business might have an offer to be purchased. Each of these would most likely require knowing the value of company-owned equipment. While these are all “event-based”, some business owners feel it is a good idea to have a strong grasp on what the value of their equipment is. It also may make sense to get different “quotes” or expert appraisals.
Based upon what a small business needs the information for, there are several methods that can be used that will give the value of an asset and the method you use may depend on the data you have available. The first three methods could be considered dependent, because the typical business owner would need to have the value calculated by another source. Three of the most common methods of calculating equipment are the cost approach, the sales approach and the income approach.
The cost approach is exactly what it sounds like – it takes into account the cost to substitute or replace the piece of equipment in question. The baseline would be the cost of substituting the equipment with a brand new version. It would involve the item to be appraised to calculate how much it has depreciated and if it is still functional or has a market or salvage value. Knowing the depreciation expense of equipment is also necessary for tax purposes. It is also possible, based upon the industry and with improvements in technology, that the replacement cost may be lower than expected, which would be good for any business’s balance sheet and also possibly create more cash flow, but would impact the book value of an asset in a negative way.
The income approach to valuation is a bit trickier because it attempts to find a value to how much income a particular piece of equipment creates. This is a difficult approach and not as practical when discussing readily-available equipment that can be replaced. With so many other factors that go into revenue, with the exception of larger pieces of equipment (boats for example) there aren’t really any ways to make a direct connection between equipment and created cash low or revenue.
Another approach, often used in real estate is the sales or market approach. In fact, it is almost exclusive to the real estate industry. When using this approach, an appraiser uses comparable sales along with any similar listings and information gained from anyone that might specialize in the equipment being appraised. When the market is limited – or nonexistent – it’s time to consider another approach to determining value of equipment.
This leads to perhaps the simplest way to independently calculate equipment value is through a Straight Line Depreciation Method. The key term here is “independently”. If you don’t have access to an accountant, this method can work for any business. Although it may sound difficult and confusing, it is actually a simple formula to work through and it will work for a majority of equipment types without having to delve into the other more complicated appraisal methods. In fact the IRS website has a section devoted to depreciation.
It’s a pretty straight-forward method. For example, using this approach, if a food service industry owner had a commercial oven that was originally purchased for $4,000. The market has several used ones that still have some market-value, so you feel that after 5 years of useful life based on the IRS category, if maintained, would still have a value of $1,500. The simple equation for straight line calculation would be to take the original cost ($4,000) and subtract from it the value after its use ($1,500), then divide by the amount of years of use (5). So in this scenario, the Straight Line Depreciation would be $500 per year. It is actually that simple. That is why it can be such a good resource for small business owners.
The Straight Line Depreciation method can assist in deductions for tax purposes or for simply trying to gain an understanding of the value of a business. “I like to know the value of my equipment as it was calculated for insurance,” said Thomas Coniglio, owner of Tomaso’s Catering, a business that includes a vending kiosk and a commercial kitchen. “But, I like to always have an understanding of my equipment and my business in general. When I have that knowledge, it can only make me a better owner. Knowledge is power and this method can help with that”
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