First step to efficient asset recovery: Adopting correct method for establishing fair market Value

By Sharad Sharma

An asset recovery professional has an exciting routine. He may have a regular job yet he is working as a multiple position holder. In one of the very common occurrence across the spectrum is when he receives a notice from one of his internal customers that a nice piece of machinery needs to be sold in a short time frame. All of the required releases and specifications are attached except financial information (original purchase price or net book value). A new project with loads of independence to market the asset.

Determining Fair Market Value

Pondering, getting acquainted with the asset and establishing a fair market value (FMV) could be the logical point to commence on this project.

SWAG: When determining the fair market value (FMV) of any asset, there are several approaches that are used regularly. They are the cost approach, market approach, income approach and, occasionally, the Scientific Wild Axe Guess (SWAG) approach. The first three mentioned are generally accepted approaches taught by the American Society of Appraisers and supported by various professionals across the globe. The fourth, while in general use in the industry, is less formalized and more subjective. Appraisals are always marked by time. Values fluctuate for a number of reasons, such as supply, demand, changes in regulations and the level of technology. Any opinion of value must be tied to a certain date.

Cost Approach: The cost approach relies on the Principle of Substitution, which states that an informed buyer will not pay more for a used asset than for a new asset of similar utility. This means that the upper limit of value starts with the replacement cost new (RCN) of a similar unit. Starting with the RCN, the value is depreciated (adjusted) based on its physical condition, functional considerations (inherent in the asset itself) and economic considerations (external to the asset). The RCN is typically depreciated in the order stated above; keeping in mind that 0% depreciation in any category is a possibility. Physical depreciation can be estimated through a physical inspection of the asset, by interviewing operators or maintenance personnel, or by evaluating the normal life of the unit compared to its actual age (age/life comparison).

Functional depreciation may be considered in the cases of lower production capacity than a new unit, the cost to upgrade to more efficient controls, excess capacity or other aspects of asset that may detract from or enhance its value. Economic depreciation is typically considered as separate from the asset itself. A change in a government regulation that requires stricter emission controls is an often-cited example.

Market Approach: The Market Approach is based on the assumption that data from actual sales of identical or comparable (similar) assets is an indication of the FMV. This approach is best used for assets that have an active market with published results. In this approach, sales of exact matches (age, condition, production, size, etc.) to the subject will provide the best indication of value. However, it is rare to find exact matches, so the appraiser must adjust the comparable to match the subject. The art of this approach is taking advantage of experience to quantify the adjustments. While there is no standard, the amount of an adjustment for each aspect of pertinent data (year of age, condition, sale channel, etc.) must be determined and noted by the appraiser.

Income Approach: The Income Approach requires that the subject assets’ earning capacity be investigated and that the present value is supported by the expectation of future earnings. This approach is seldom used for individual pieces of machinery because it is difficult to assign income to any particular fixed asset.

Finally, the SWAG approach is much more subjective than objective. Wikipedia gives an apt definition of SWAG approach: ‘Scientific wild-ass guess (SWAG) is an American English slang term meaning a rough estimate made by an expert in the field, based on experience and intuition. It is similar to the slang word guesstimate, a portmanteau of guess and estimate’.

Not to ignore various subjective traits: the brand of the asset, country of origin and the number of ownership the asset has had in its lifetime. These all play vital role in the appraisal of the asset.

Sharad Sharma is Co-founder of UAE-based ARSIM Services. This article was first published by the author on LinkedIn. InsolvencyTracker.in has taken permission from the author to publish this article.

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