What is Your Equipment’s Net Residual Value, and Why Does it Matter For Your Budget?
June 6, 2019 | Last Updated on: July 18, 2022
June 6, 2019 | Last Updated on: July 18, 2022
The term Net Residual Value, or NRV, is one almost all business owners have heard as they’ve worked to finance their businesses. But you might be struggling to define exactly what that phrase means, why it matters to your business, or (most importantly) how you can calculate it for your own financing needs.
First, let’s define the concept of Net Residual Value, which is sometimes also called the equipment’s scrap value. In the simplest terms, a piece of equipment’s NRV is what your item — whether it be a truck, machine, or stove — is worth once it is no longer useful. The best way to think of it would be to consider what the dollar value of your truck, machine, or stove would be once it has broken down. Fortunately, this number is determined by your equipment’s manufacturer and is fairly straightforward to find out: Call or email them.
Knowing this value is extremely important for business owners for two reasons. One, because you need to know how long your equipment will last before you have to replace it. And two, because lenders use this number to help calculate how much financing they will offer you. Both you and your lender need to know just how long the equipment in question will last in order to figure out your financial plan for the future.
Let’s take a restaurant as an example.
The restaurant owner will need to know how much life a stove has left in it, so that they can use financial projections to see whether they’ll be able to replace it with more financing, less financing, or (best of all) no financing. If the restaurant owner needs to finance a replacement stove, showing a lender their calculations also shows that the restaurateur is serious about creating a good business plan. A good business plan is an important element in securing a business loan.
For the lender’s part, knowing the existing stove’s NRV allows them to figure out whether the restaurant looks like a good credit risk. It also helps them figure out how much they’ll lend the business owner.
Knowing the NRV of your equipment will become particularly important as it depreciates to the point where it will need to be replaced so that you can prepare for the inevitable big purchase to come.
The the straight line method is prized for its simplicity. It’s good for a quick general overview.
Here is all of the information you need to use the straight line method:
Once you have these numbers, you just have to subtract the salvage/scrap value of your stove (or other equipment) from the its original cost, and then divide that number by the number of useful years. That number is how much your equipment will depreciate each year.
For example, if you have a stove that is worth $7,000 new, with an expected lifespan of 10 years and a final scrap value of $2,000, that stove can be expected to depreciate $500 each year until it needs to be replaced.
Straight Line Method Equipment Calculator
You can see how the straight line method works on the Biz2Credit Equipment Value Calculator. You’ll be then prompted to enter the cost of your equipment followed by its residual value. Last, you’ll be asked to input the equipment’s number of useful years. Hit calculate, and there you are.
Those who would like a more exact way to calculate depreciation can try one of these other methods:
In order to calculate the depreciation rate of your equipment using this method, you will need these figures:
That last figure requires a little bit more calculation. In order to figure it out, just use the following formula: 100%/useful life x 2. So for the stove in question it would be: (100% divided by the 10 years of the stove’s usefulness) x 2. That means our depreciation expense is 20% each year.
This is how your stove will depreciate over the first 3 years:
When the $7000 stove depreciates the first year, ($7000 x 0.20) = $1,400.
$7000 – $1400= $5,600, which is the value of your stove at the beginning of year 2.
By the end of the second year, your stove will depreciate another $1120, and will be worth $4480 as the stove heads into year 3.
This method is built on the assumption that your equipment will depreciate the most in the early years of its useful life. The phrase “sum of years” (or “sum of the years”) refers to part of the formula where you add up the number of years of the equipment’s expected life. For a washing machine expected to last 3 years, you would add 1 + 2 + 3.
To figure out the Depreciation Expense of our stove, we will use the following formula:
Depreciation Expense = (Remaining Life / Sum of Years) x (Initial Cost – Salvage Value)
Let’s look at the stove again. It costs $7,000 new, is expected to last 10 years, and be valued at $2,000 scrap. Let’s say it’s 1 year old.
In this case, the Depreciation Expense = (9 / 1 + 2 + 3 + 4 + 5 + 6 + 7 + 8 + 9 + 10) x (7000 – 2000), or a depreciation of $818.18 the first year.
At age 2, the Depreciation Expense = (8 / 1 + 2 + 3 + 4 + 5 + 6 + 7 + 8 + 9 + 10) x (7000 – 2000), which is $727.27.
And so on.
This depreciation method calculates the number of units of product your equipment would create over the course of its useful life. For this example, we will use the case of our restaurant’s ice cream maker, which costs $3,000 and will be worth $300 at the end of its useful life. If the machine creates 500 scoops of ice cream a year, that means it will create 5,000 scoops over the course of its useful life.
Figuring out the Depreciation Expense in this instance uses the following calculation:
Depreciation Expense = (Number of Units Created / Number of Units over course of Useful Life) x (Cost – Salvage Cost).
Using this formula, our ice cream machine’s Depreciation Expense would be = 500 / 5,000 x (3,000 – 300) or $270 during the machine’s first year of use.