How do you evaluate machines, Mr Merker?

Table of contents

1. Purpose of evaluation

2. What is the machine value needed for?

3. Which machine value is to be determined? 

Special cases: Compensation and damages

What is the significance of the book values of fixed assets?

4. How to value machinery – The methodology

Machinery inventory

Physical inventory

How do you determine the new or replacement value of a machine?

Acquisition and production costs

How do you determine the market value of a machine?

Assessing the individual condition

Remaining useful life

Residual value

Depreciation methods

5. Plausibility check

Purpose of evaluation

Before we talk about methodology and ways, it must of course first be clarified what the purpose of the evaluation is. Because what value or values are to be determined depends on this. Then, and really only then, does it make sense to choose the valuation method.

So let’s start with step 1 and clarify:

What is the machine value needed for?

The most important valuation occasions we have to deal with are these:

• Determine insurance sums (property insurance or fixtures and fittings insurance for companies)
• Meeting financing needs (bank loans, sale and lease back, subsidies)
• Carry out corporate transactions (sales, acquisitions, due diligence, M&A)
• Determine balance sheet values
• Resolve disagreements with tax authorities (inheritance, intra-group transactions)
• Calculate compensation for relocations (infrastructure projects)
• Raising depreciation potential (asset deal)
• Clarify disputes between shareholders
• Determine insurance losses and loss amounts

The purpose of the valuation determines which machine values we determine.

Once we have clarity on this, we come to step two:

Which machine value is to be determined?

In our valuation practice we basically distinguish between new values and net asset values, whereby there are countless synonyms for these two terms.

New value: Replacement value
Net Asset value: Sales Value, Common Value, Market Value.

Depending on the industry or sphere you are in, you will come across different terms.

If you want to know more about the individual terms, where they are used and what they mean exactly, we recommend our article “Value terminology in machine evaluation“.

We do not need to consider most of the subtleties and usages. In our valuation practice, what matters is the connection between the purpose of the valuation and the valuation approach, which looks like this:

Special cases: Compensation and damages

So-called relocation appraisals are a special case. This involves determining the costs that arise when entire businesses are relocated. This happens, for example, when the public sector wants to implement infrastructure projects and needs land that is currently used by commercial enterprises.

A prominent example is Hamburg’s Hafencity: the site where the Elbphilharmonie Concert Hall, the Maritime Museum, countless new flats and chic offices now dominate Hamburg’s city skyline used to be the location of many businesses. Our office has calculated the relocation costs for many of these businesses on behalf of the City of Hamburg.

The costs for the relocation are reimbursed to the enterprises. So it is a compensation sum that we calculate. For this, both replacement values and fair values, the reassembly and dismantling costs as well as the costs for transport are needed.

However, the calculation of compensation for such relocations is not the subject of this article.

Another extra topic is damage assessments in the case of property damage, which then form the basis for the reimbursement of property damage and business interruption loss by the insurance company. We have already written on this, namely on the topic of “Business interruption damage” and “Expert procedures“.

In summary, therefore, the following machinery and plant values to be determined can be assigned to the valuation events:

•  Insurance sums: replacement values
• Covering financing requirements: net asset values
• Company transactions: fair values, net asset values
• Determine balance sheet values: fair values, net asset values
• Disagreement with the tax office: net asset values
• Raising depreciation potential: net asset values
• Disputes: net asset values

In addition, the new or replacement value is actually always required in order to check the plausibility of determined market values. And – depending on the initial situation – both values can or must be used in order to have a point of reference at all.

What is the significance of the book values of fixed assets?

Basically, we do not pay much attention to the values that have to be looked up in the fixed asset register of the annual financial statement (i.e. the book values) for the following reasons:

The valuations in the balance sheet rarely match the actual values of the fixed assets (By the way: If they did, nobody would need our services). The valuations in the balance sheet arise from the capitalisation of the production or acquisition costs and are then depreciated to the book values according to the applicable tax or commercial law rules. However, these have only very coincidentally something to do with the economic reality and the actual wear and tear of the fixed assets.

The amount of tax depreciation, for example, is often politically motivated: keyword special depreciation – which you can currently apply, for example, if you convert commercial space into rental flats. Or the current corona depreciation, which allows geometric-degressive depreciation on movable fixed assets purchased in 2021 and 2022. And do you still remember the 50% special depreciation after the german reunification?

With the depreciation options under commercial law, on the other hand, the company has the choice between different depreciation methods. Often the company’s current balance sheet policy determines which method is used and thus the amount of the book values.

And quite honestly: you probably also have various machines and equipment in use that have long since been written off and which continue to eagerly do their job.

Nevertheless, the summary of fixed assets is the first document we request when we receive a valuation order, because the items listed there serve us for orientation and plausibility checks.

Now that we know which values are needed for which purpose, we can deal with the methodology and finally answer the question in step three.

How to value machinery – The methodology

Machinery inventory

As already explained, the first thing we look at is the summary of fixed assets, because it gives us an initial orientation about the size, age, type and composition of the machinery and operating equipment.

Physical inventory

Next, we come around and look at the company or the machinery and equipment being assessed. We call this a “physical inventory” and we always do this. Without exception.

A pure “desk assessment” without ever having seen the object of assessment is not possible in our eyes. With our “seal”, we assume responsibility and ultimately liability for the correctness of the values determined.

In the event of fire damage, for example, this can be crucial to the existence of a company. Only if you can prove that your sum insured is correct you will be entitled to full compensation. If you want to learn more about the existential importance of the right sum insured, we recommend these articles.

At the end of the day, you pay us so that you can sleep soundly, are adequately insured and don’t have to “blow your top” in court, at the tax office or in the event of a claim. And that is why we look at what we value.

Depending on the value we determine, however, other aspects are relevant for us during the “inspection”.

If, for example, we are determining the replacement value for insurance purposes, we are primarily interested in everything that belongs to the business, regardless of legal ownership, but according to the insurance conditions (at the latest at this point, every summary of fixed assets fails).

In the case of market value, on the other hand, we are interested in the technical condition, age, mileage to date, maintenance, upgrades that have been carried out, and so on.

How do you determine the new or replacement value of a machine?

The new value or replacement value is the replacement price for the asset in new condition, including the ancillary costs for procurement and assembly until it is ready for operation.

To arrive at these values, we have various options. Which one we use depends on the type of machine or asset.

1. Empirical values

In the case of very typical, recurring equipment without special features, we simply know the new prices (for us, this knowledge is part of the job description). You can imagine this as with your chief buyer – he simply knows the prices on the market. Typical examples are office chairs and tables, lathes and grinding machines.

2. Own data sets

For more than sixty years we have seen several dozen companies every year. As diverse as they are, there are certain types of machines and equipment, industry-specific – but also cross-industry – that come up again and again. Over time, we have built up an enormous database treasure trove, which we draw on for every assessment. Especially when we have already evaluated other companies in the same industry, this is an important resource for our work.

3. Research

A very important part of our work is research. That means we talk to manufacturers and research prices. The difficulty here is, on the one hand, knowing the manufacturers and being able to approach them.

The second hurdle, however, is to identify the corresponding modern counterpart of machines that are no longer produced in this form and to quantify its value in relation to the value of the “old” machine. Ultimately, this is always a case-by-case assessment whose plausibility stands and falls with the justifiability of the assumptions we make.

Perhaps you know this from other areas: The work of an expert consists to a large extent of making assumptions and making them plausible in such a way that they are comprehensible to any third party.

4. Extrapolating or indexing

Especially for machines that are rare or even very specific, we use the technique of extrapolation. For this we need the acquisition or production costs.

Acquisition and production costs

When determining the acquisition and production costs, it is important to note that certain special discounts (trade fair prices, auction prices, distress sales) must be disregarded. Also, very specific or self-constructed assets, which may have been created over a longer period of time, must be considered individually.

In the simplest case, we can extrapolate the acquisition or manufacturing costs of the machine by applying value allowances. Often, however, we have to mentally break the machine down into components, each of which is then indexed with its own value additions. This is important because certain indices only apply to certain product groups. It also gets complicated when we are dealing with machines that were not manufactured “in one piece”.

The correct use of indices is tricky and limited. If you want to know more about this, read this section.

5. Recalculation together with the customer

In the case of certain machines and plants that are completely customised or have been built by the company itself, we sometimes calculate the replacement value together with the customer and delve into the construction plans and cost statements. We often combine this with the up-indexing of individual components and business calculations.

This approach is very typical for prototypes and start-ups.

6. Consideration of costs for delivery, freight, assembly

As mentioned at the beginning, the value as new or replacement value also includes all costs incurred to make the machine ready for operation. This includes delivery and freight costs (what use is the machine to you on your supplier’s premises?), assembly costs and, if applicable, training, but also, for example, foundations that have to be poured.

These costs can range from 1% – for a simple lathe – to over 100% for petrochemical plants, for example, and are calculated by us specifically for each machine and plant.

How do you determine the market value of a machine?

Whether we are talking about net asset values values, fair values or market values, all terms are based on the following consideration, namely

that the net asset value is the price that could be achieved in the ordinary course of business and depending on the nature of the asset in the event of a sale. All circumstances influencing the price are to be taken into account – but not unusual or personal circumstances.

This is how the Valuation Act and the Building Act define it, among other things.

The challenges in determining net asset value are therefore different from those in determining replacement values. Factors such as the individual condition of the machine, the marketability or the third party usability have to be assessed. In addition, it is also necessary to assess which general conditions influence demand and – thus – also the market values.

This includes, for example, knowing the current state of the technology, because a machine that is no longer technically “up-to-date” can (but does not have to!) be valued lower.

The supply bottlenecks that can currently be observed worldwide also influence the market values of many machines.

How do we proceed now?

1. Research

Valuation at market value also starts with detailed research. As far as marketable machinery is concerned, we can already obtain an initial overview via various trading platforms on the internet (such as trademachines.com). We supplement this information with price information obtained directly from machine dealers and auctioneers. We therefore research as many second-hand markets as possible with the aim of obtaining a sufficiently large number of comparative values. The comparative machines should include as many as possible with comparable maintenance condition and mileage. Of course, this is only rarely possible, even with very common machines and systems, so that we actually always have to check the plausibility of the values found and back them up.

2. Own data sets

To do this, we again use our own data sets and our experience. Most of the time, we can estimate which factors influence the values and how, based on traffic values that we have once documented, even across machine types. But also in the case that machines rarely appear on second-hand markets, our first look goes into our own data.

Assessing the individual condition

Our own data are decisive in order to cluster machines sensibly with regard to their current condition. This depends on the general maintenance and repair status, the current work quality and the condition of the accessories. Based on our data, we can cluster machines according to these criteria and thus quantify the current condition for each individual machine to be evaluated. In the valuation, this is reflected in corresponding surcharges and discounts.

3. Derive fair values

In the next step, we look at the historical acquisition and production costs, derive new or replacement values from them and calculate the wear and tear.

We have already outlined what needs to be taken into account when determining acquisition and production costs and how we calculate new values from them using indices in the section Determining new values. The procedure is analogous.

For depreciation, too, we do not fall back on depreciation regulations under commercial law or even tax law – as already explained – but orient ourselves on economic reality.

The decisive parameters are the remaining useful life, the residual value and the depreciation method to be chosen.

Remaining useful life

The remaining useful life is the answer to the question “How long will it last?” and depends on the total useful life and the period of use to date.

The depreciation tables of the (German) Federal Ministry of Finance (BMF) on the useful life of fixed assets provide orientation, but it is essential that they are checked for plausibility (and corrected if necessary!) by an expert (i.e. on our part) with regard to the actual total useful life. The rest is then simple subtraction.

Residual value

We are also concerned about the possible residual value of a machine at the end of its service life.

By residual value we mean the value of a plant or machine that can no longer be used for its original purpose minus the costs incurred in recycling it. For example, the price of scrap metal minus the costs for the scrap dealer who collects the machine.

We also usually arrive at this value based on comparative data and/or dealer enquiries.

Depreciation methods

A basic distinction is made between straight-line and declining-balance depreciation methods. With straight-line depreciation, the same amount is reduced each year; with declining-balance methods, the amount of reduction is highest at the beginning and then decreases year by year. This effect is greatest with geometric-degressive depreciation (compared to arithmetic-degressive depreciation).

We usually use declining-balance depreciation methods because they most closely reflect the actual depreciation of a machine, which is usually greatest in the first years of use. Ultimately, however, we are also free in our (justifiable) choice here if certain circumstances need to be taken into account.

Some machines, for example, already lose value when they leave the producer’s yard. Here, for example, a corresponding deduction can already be made before the actual depreciation series is started.

Plausibility check

The last thing we do is a plausibility check to see whether the values we have found (new values, net asset values and comparative values) are consistent and fit together. We also check the consistency of our assumptions and calculations and – of course – make any necessary corrections.

And what happens next?

We remember the actual purpose of the valuation and the mandate we were given and draw up a corresponding expert opinion, which then provides the insurance company with the insurance values, the bank with the lending values and the tax office with the tax values.

Phew, we’ve come a long way. If we were sitting together now at an evening event, the bottle of red wine would probably be empty.

Until then, very cordially,

Yours, Philip Merker