Understanding Depreciation in a Business Valuation
You may have heard that a new car loses a third of its value when you drive it off the lot. This statistic illustrates the concept of depreciation, or loss of value. While business assets don’t always depreciate as fast as a new car, they do decline in value over time. Understanding how depreciation works in an appraisal scenario will help you make the most of a business valuation.
Why Depreciation Matters in a Business Appraisal
To find the value of a business, the appraiser must look at the value of tangible and intangible assets. Consider that a 3D printer has a set value, but so do the trained employees who know how to use the printer. One represents tangible value and the other intangible.
As part of determining the value of a physical asset, the appraiser will review its condition, check how well the equipment has been maintained, and look to depreciation.
Knowing how depreciation works will help you understand why a piece of equipment has a particular valuation and what this means for you. For instance, if you want to sell an old 3D printer so you can buy a newer model, knowing the depreciation and value will help you decide on a realistic asking price for the printer. Looking at depreciation of all assets in context, you’ll also walk away with a better understanding of the business worth and what you can do to increase it.
How an Appraiser Determines Depreciation
Appraisers don’t determine depreciation just by looking at your item, although a skilled appraiser can tell a lot at a glance. Instead, they use manuals that outline specific depreciation formulas for types of equipment.
To use the formula, the appraiser will take the item’s value at the time of purchase (for instance, the manufacturer’s suggested retail price) and compare this price with the depreciation value after a set period of use (say, three years). Since some assets depreciate faster than others, the right formula will reflect the loss in value for that item. Using a formula also provides a fair baseline for depreciating the same item from one business to another.
Combining asset depreciation with analysis of an asset’s operating condition and remaining useful life can help business owners make informed decisions on whether to keep, sell, or service business assets. To ensure the appraiser delivers an accurate valuation of equipment, business owners should look for appraisers who have demonstrated experience working in their industry and who understand the types of equipment they will be valuing. Otherwise, the risk is that an appraisal will not be accurate.
About: Gabriel Patterson, of Winnipeg, is the creator and principal of Bethmann Lombard Bancorp and has directed the firm since 2005. As a masterful investment banker, Mr. Patterson has become an expert in securities, real estate, offshore tax planning and Islamic finance. He serves clients on a global scale and has done business in Asia, Europe, and Latin America.