Important Role of Insurance Valuation in Assessing Business Health

During assignment for Insurance valuations of fixed assets on re-instatement basis, usually clients ask for report on market valuation basis as well to know the current worth of their business.

In addition, the periodical market value/depreciated replacement cost valuation may be helpful in understanding a company’s overall financial health also for the business owners.

During preparation for ‘Plant and Machinery Valuation certification’, came across the following very important publication, which in my view will be very helpful in understanding the concept presented here:

 STANDARDS ON VALUATION OF PLANT, MACHINERY AND EQUIPMENT, Prepared by CVSRTA Registered Valuers Association & Centre for Valuation Studies, Research & Training Association

In the practical world of business operations—: comprehensive valuations are time-consuming, costly, and require complex inputs that may not be readily available or justifiable outside of key strategic events such as mergers, acquisitions, or financing rounds.

In this context, insurance valuation may offer a more practical and cost-effective alternative that can still serve as a meaningful indicator of business health.

Unlike full enterprise valuation, which attempts to capture the total worth of a business based on future cash flows, market comparables, insurance indemnity valuation focuses on the market (DCR) value of physical and tangible assets. While more limited in scope, this approach may provide insights into the present economic condition of the business, especially when done periodically.

One of the significant advantages of insurance valuation (Depreciated Replacement Cost basis) is that it can be utilized for finding economic obsolescence—a critical element in asset-heavy businesses.

“Economic obsolescence exists, if the economic support for fixed and intangible assets is less than the fractional values of the identified assets, as individually estimated by the depreciated replacement cost or sales comparison methods, as the case may be.

Business enterprise value less net working capital represents the economic support for fixed and intangible assets.

Share Holder’s Equity + Long Term Debt = Net Working Capital (Current Assets - Current Liabilities) + Fixed Assets + Intangible Assets

Followings are readily available from company’s financial reports for the necessary deduction

CA = Current assets

FA = Fixed Assets

IA = Intangible Assets

CL = Current liabilities

 LTD = Long-term debt

SE = Stockholders’ equity

If there is excess economic support for the underlying identified assets, it is concluded that unidentified intangible value exists, which is generally considered to be goodwill or going concern value. 

Once economic obsolescence is suspected, a full business valuation may be initiated with the help of specialist Chartered Accountants and remedial measures undertaken.

In essence, while insurance valuation is not a replacement for full enterprise appraisal, it offers a fair and objective framework for monitoring key indicators of business health. Its periodic execution aligns better with operational realities and can serve as a proactive tool for risk management, strategic planning, and resource optimization.

Important Caveat: It's an Indicator, Not a Substitute

Of course, a DRC-based valuation is not a replacement for a Sales Comparison or full-blown income approach. It doesn’t factor in future cash flows, competitive dynamics, or goodwill. But as a practical, cost-effective tool for interim business checks at the time of insurance policy renewals, it may offer additional utility.

In summary: Think of DRC-based insurance valuations not just as a risk management necessity, but also as a financial wellness tool. When interpreted smartly, they can spotlight trends in obsolescence, underline capital misallocations, and even hint at business’s ability to generate value in today’s economy.

Reference Publication:

STANDARDS ON VALUATION OF PLANT, MACHINERY AND EQUIPMENT, Prepared by CVSRTA Registered Valuers Association & Centre for Valuation Studies, Research & Training Association.

The above interpretation is absolutely personal in nature and is not binding on any individual or organization in particular.

 Title: Predicting Equipment Resale Value: A Handy Guide for Indian Contractors

When it comes to heavy construction machinery, knowing when to sell can be just as important as knowing what to buy. For many contractors, this boils down to one key question: “How much will my machine be worth after a few years of use?”

Drawing inspiration from a publication by Dr. Gunnar Lucko at Virginia Tech, here's how Indian contractors can make smarter decisions using data, not guesswork.

🏗️ Case in Point: JCB 3DX Backhoe Loader

A regional road contractor in Maharashtra purchased a JCB 3DX backhoe loader in 2018 for ₹32 lakhs. After 7 years of operation, here's the financial picture:

• Fuel cost: ~₹34 lakhs (based on 1,200 hrs/year @ ₹90/litre)

• Maintenance cost: ~₹6.5 lakhs

• Estimated resale value (2025): ₹18.5 lakhs (58% of purchase price)

• Projected value in 2028: ₹11.2 lakhs (35% of purchase price)

Net cost of ownership (7 years): ₹54 lakhs

🧮 Dr. Lucko used statistical modeling to calculate optimal resale timing by factoring in:

• Age and condition of the machine

• Manufacturer brand perception

• Regional auction trends

• Macroeconomic indicators (like inflation and GDP growth)

🔄 Smart Decision: Sell Now or Wait?

For this contractor, selling now brings a better return, avoids rapid depreciation, and allows investment in an upgraded model like the JCB 3DX Super or CAT 424 4WD, both offering better fuel efficiency and higher resale value down the line.

💡 Final Thoughts

Most site managers don’t have time for spreadsheets and regression curves. But even a simple understanding of how resale values behave can:

• Strengthen your bids

• Reduce total owning cost

• Improve fleet planning

If you're interested in a free Residual Value Estimator sheet tailored to Indian machines, drop a comment below or reach out!

Author’s Reflection > > During my years on construction sites, I often saw valuable machines—graders, backhoe loaders, dumpers—left idle in the yard for weeks, sometimes months. Repairs delayed. Spare parts unavailable. Maintenance teams scrambling, sometimes forced to cannibalize components from older machines just to keep newer ones running. > > These hard-earned observations shaped my perspective on how critical equipment lifecycle planning really is. > > This article was created with the support of Microsoft Copilot—helping translate complex financial models into practical insights for those who keep our infrastructure moving, often against all odds.

The above is my personal interpretation on the subject and has been composed with help of Google Copilot.

 

Title: Repair, Replace or Discard? Understanding the Real Value Behind Your Assets

We all have that one favorite item—a watch gifted years ago, a handbag we carry everywhere, or an old kitchen appliance that has served us loyally. When these items start to wear out or malfunction, we’re faced with a decision: Should we repair it or replace/discard it?

This decision, surprisingly, isn't always made on sound financial logic. More often, it’s driven by emotion and habit. And that’s where we go wrong.

Let me give you two real-life examples from my own experience.

My wife recently spent ₹1,000 to repair a wristwatch whose purchase price was around ₹700. In another instance, she was willing to spend ₹300 on fixing a handbag that originally costed her ₹300—and has already seen years of use. Her reasoning? “I like it.”

I couldn’t help but reflect on how such decisions ignore some basic—but crucial—principles of asset valuation.

Rational repair/ replacement /discard decision is much more crucial in business environments, where the financial stakes are much higher. 

Many Industrialists reluctant to let go their aged old non-functional equipment insure these separately as obsolete assets in their property insurance policies. 

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Emotional Attachments vs Economic Value

We tend to form emotional bonds with our possessions. That’s human. But when it comes to spending money, especially on repairs, emotion can cloud rational judgment.

The economic value of an asset is not the same as its original purchase price. As time passes, most items depreciate—they lose value due to wear and tear, obsolescence, or simply changes in taste and utility.

The Three Pillars of Repair Decisions

When considering whether to repair an asset, we should ideally evaluate:

1. Current Market Value (CMV)
   What is the item worth today, if you tried to sell it?
2. Residual Value (RV)
   What is the item expected to be worth at the end of its useful life?
3. Remaining Useful Life (RUL)
   How much longer can the asset realistically serve its intended purpose after repair?

Now apply this to any repair decision:
If the cost of repair exceeds the CMV, and the RUL is short, the repair is likely not justified—financially speaking.

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A Simple Rule of Thumb

A good benchmark to use:

Repair cost should not exceed 50% of the item’s current market value, unless the item has a long remaining useful life or exceptional utility.

Of course, there are exceptions. Heirlooms, sentimental gifts, or rare collectibles may warrant a different approach. But for everyday items, this logic helps prevent throwing good money after bad.

How to Think Like a Valuer

Before making your next repair decision, pause and ask:

• How old is the item?
• What is its resale value today?
• How long can it continue working effectively?
• Is the cost of repair proportionate to its value and future service potential?

This mindset shift can lead to smarter financial decisions and better resource allocation—not to mention less clutter and fewer regrets.

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Conclusion

Valuation is not just for accountants, insurers, or investors. It’s a life skill. Whether it’s a ₹700 watch or a ₹30 lakh machine, we must learn to separate emotional worth from economic value.

Let’s be rational where it matters—and reserve our sentiment for things that truly deserve it.

The above interpretation is absolutely personal in nature and is not binding on any individual or organization in particular.

 

 Can Fire in Cotton Bales be treated as Spontaneous Combustion:

Cotton bales covered under the Standard Fire and Special Perils (SFSP) policy are stored in covered warehouses without any electrical cabling inside.

"Often, in the event of a fire, representatives of the insured often attempt—out of both ignorance and sincerity—to prove that the cause was spontaneous combustion."

Standard fire and special perils policy does not cover spontaneous combustion, which is an ‘add on’ in fire insurance.

Cotton is assigned to Class 4.1 of the IMDG Code (Flammable solids) and not a spontaneously combustible material.

 Cotton fires often begin as smoldering fires, which can burn internally for extended periods before erupting into flames. This can make it difficult to detect the fire until it's well-established. The considerable compression prevents the fire from spreading as quickly as it would spread through uncompressed bales.

However Specific characteristics and negative external influences may cause cotton bales to behave like a substance from Class 4.2 (Substances liable to spontaneous combustion) of the IMDG Code.

Self-heating / Spontaneous combustion

Cotton bales can spontaneously combust due to various factors, including dampness, oil contamination, and improper storage, leading to smoldering and eventual fire. The tight packing of cotton within bales allows for internal heat buildup, particularly when damp or oily, which can lead to ignition. 

• Dampness:

When cotton is pressed or baled in a damp state, it can generate heat internally, especially if the moisture content is high and the heat cannot dissipate. This heat buildup can eventually reach the ignition temperature, leading to spontaneous combustion. 

• Oil Contamination:

The presence of oils, even in small amounts, can significantly increase the flammability of cotton and lower the temperature at which it can spontaneously ignite. 

• Improper Storage:

Stacking bales too high, inadequate ventilation, or improper spacing can contribute to heat buildup and the risk of spontaneous combustion. 

• Microbial Activity:

Microbes can grow and reproduce in damp cotton, generating heat as a byproduct of their activity, which can further contribute to the risk of spontaneous combustion. 

Spontaneous Combustible Materials

The following materials should preferably be notified to insurer and covered as ‘add on’ in fire insurance policy.

The following materials can be subdivided based on their propensity to spontaneously:

(Reference: sovereigninsurance.ca)

Strong Propensity: Charcoal • Cod liver oil • Fish oil • Fishmeal • Fish waste • Linseed oil • Clothing, silk, fabrics and rags soaked with oil • Tung nut flour (or tung, or Chinese wood) • Peanut seed coat (skin covering the peanut, under the shell) • Pigments in Oil • Cornmeal based pet food

Average Propensity: •Food for animals • Foam rubber • Certain metallic powders • Bituminous coal • Fertilizers • Hay • Coconut bark • Manure Distillery or brewery beans • Whale oil • Cottonseed oil • Corn oil • Menhaden oil • Perilla oil • Pine oil • Soybean oil • Tung oil (or tung oil, or Chinese wood) • Red oil (unrefined palm oil) • Roofing papers and felts • Paint containing drying oils • Pyrite • Rubber residue • Wool residue • Paper waste

Low Propensity: •Cotton seeds • Mustard oil • Palm oil • Peanut oil • Turpentine

The above interpretation is absolutely personal in nature and is not binding on any individual or organization in particular.

 

EFFECTIVE LIFE & REMAINING USEFUL LIFE OF PLANT & MACHINERY

To determine the effective life and remaining useful life of plant and machinery, one needs to consider the asset's physical condition, operational performance, and the applicable depreciation methods. The effective life is the period during which the asset is expected to be used productively, while the remaining useful life is the estimated period from the current date until the asset is no longer expected to be used. 

1. Understanding Effective Life:

Effective life refers to the period an asset is expected to be used productively, considering factors like physical condition, technological advancements, and operational performance. It's a more practical estimate than the legal or statutory useful life, which may be specified in accounting standards or tax regulations.

2. Factors Affecting Effective Life:

• Physical Condition: Regular maintenance, wear and tear, and potential damage can impact an asset's physical condition and, consequently, its effective life.

• Technological Advancements: New technologies and innovations may render older equipment obsolete, shortening its effective life.

• Operational Performance: How an asset is used, the frequency of use, and the intensity of operations can affect its effective life.

3. Determining Effective Life:

• Historical Data: Analyze past maintenance costs, repair records, and production data to assess the asset's historical performance and predict its future performance.

• Manufacturer's Specifications: Consult the manufacturer's recommendations for maintenance schedules and expected lifespan.

• Expert Opinion: Seek professional advice from engineers, valuers, or other experts familiar with the specific type of plant and machinery.

4. Remaining Useful Life:

The remaining useful life is the estimated period from the current date to when the asset is expected to be retired or no longer used. It's calculated by subtracting the asset's age from its effective life.

5. Importance of Accurate Determination:

• Depreciation: The remaining useful life is crucial for calculating depreciation, which affects a company's financial statements and tax obligations.

• Maintenance and Replacement Planning: Accurate estimates of effective and remaining useful life help in planning maintenance schedules and replacement cycles, optimizing asset utilization and minimizing costs.

• Asset Management: Knowing the remaining useful life of assets enables businesses to make informed decisions about their asset management strategy, such as whether to upgrade, refurbish, or retire an asset.

6.       Documentation:

It's important to document the methods and calculations used to determine effective life and remaining useful life for transparency and also for insurance claim purposes.

7.            Regular Review:

The effective life and remaining useful life should be reviewed regularly to ensure they remain accurate and up-to-date, especially in light of changes in technology, operating conditions, and maintenance practices. 

The above interpretation is absolutely personal in nature and is not binding on any individual or organization in particular. 

 

Depreciation due to Deterioration of Plants & Machines

Depreciation It is the usual wear and tear caused by the normal working of any asset, its use is liable to a certain amount of deterioration despite the care and attention bestowed on its maintenance and preservation.

Physical depreciation is broken down into curable and incurable

Curable Depreciation

The following input for machinery under consideration by technical personnel of clients helps in estimating curable depreciation.

(i) Did the equipment undergo major repair or reconditioning?

(ii) Did the equipment undergo capability test?

(iii) What is the present condition in terms of production rate and accuracy vis-à-vis the original at the time of purchase?

Curable depreciation is fixable by refurbishing, rebuilding of the equipment

Physical Incurable Depreciation

Physical depreciation is caused from age, wear and tear, fatigue, exposure to the elements or lack of maintenance. Overall physical depreciation is caused more by use rather than age.

A visual inspection can help to assess present condition of the machine

General Upkeep:

If an equipment is well-maintained during its service life and is expected to operate longer with lower costs, its value may be higher than expected for a machine of its age.

Dirt, dust, and other contaminants can interfere with lubrication and cause abrasive wear on the surfaces of the rotating equipment. This can also lead to increased friction, leading to increased heat, and damage to seals, bearings, and other components. Contamination can also lead to corrosion and oxidation, which can cause parts to degrade and fail prematurely. Additionally, contaminants can interfere with the flow of fluids, cause bearing failure, cause pressure spikes, block lubricant pathways, and reduce equipment efficiency.

Observed deterioration (also known as the 0 – 100% method)

 Lump sum figure of depreciation can be adopted as given below:

 Condition                                                        Depreciation %

New (N)                                                            0 - 5

Excellent (E)                                                    6 - 10

Very Good (VG)                                              11 - 20

Good (G)                                                         21 - 50

Fair (F)                                                            51 - 70

Poor (P)                                                           71 - 90

Scrap (S)                                                          91 - 100

If upkeep and maintenance are high, then the effective age will be lower than the actual age and conversely if upkeep and maintenance have been low then the effective age will be greater than the actual age.

As one of the important obsolescence factors considered by the cost approach, physical deterioration influences the conclusion of value.

Reference Document: STANDARDS ON VALUATION OF PLANT, MACHINERY AND EQUIPMENT; Publisher: Centre for Valuation Studies, Research & Training Association, India

 The above interpretation is absolutely personal in nature and is not binding on any individual or organization in particular.

 

Taking benefit of Insurance Valuation for Asset Management

Fixed assets represent the largest item on Company's insurance budget– especially in capital-intensive industries like manufacturing, power generation, oil & gas.

While completing a property insurance appraisal, the findings can also be useful for fixed asset management as both require a physical inspection of the fixed assets inventory.

When it comes to insurable values, accuracy is vital to avoid excess insurance premiums on ghost assets.

An insurance appraisal will consider a total replacement cost of all the fixed assets and buildings. This would also include expensed assets below the capitalization threshold.

The purpose of an asset management system, or asset system, is to keep track of the equipment and inventory vital to the day-to-day operation of the business.

The only reliable way to verify and validate the fixed asset information is to conduct a physical inventory. Eliminate assets those have been lost, stolen, or unusable but are still listed as an active fixed asset in the system and also inclusion of new assets upon purchase

From insurance point of view, this means their balance sheets match up with their records, and assets that have been loaned, lost or stolen are timely identified and excluded from insurance premium. Companies not effectively managing their assets typically lose considerable amounts of time and money.

Without an accurate, real-time, organized system for tracking assets, it will be difficult to plan timely preventive maintenance of the important machines.

The benefits of an asset management system include :

·        To track and manage an asset’s entire lifecycle, from initial acquisition to periodic maintenance to phase-out from inventory

• To monitor asset use and make improvements.
• to implement preventive maintenance and routine inspections, thereby preventing expensive repairs and downtime.
• To maximize equipment lifecycles and staving off early replacements
• Reduced waste and increased profitability
• In obtaining better residual value while selling off machines due to functional or economical obsolescence

An asset management record may contain details like purchase date, serial number, manufacturer, model, lifecycle cost including maintenance and repair, present value, number of each type of fixed asset, locations, and estimated lifespans.

Such record provides a picture of the present conditions of the machineries and also help companies prepare for the future. Based on facts, they can make decisions about the assets they will need in the coming year. Subsequently, they can avoid under or over-stocking assets and manage their resources responsibly. Asset management optimizes an asset's operational performance during its lifespan and aims to keep these assets running profitably for as long as possible.

The decision to repair or replace an asset depends upon various factors, including the type of asset, age, wear and tear, and role in the production line. To decide between repairing and replacing an asset, a management company must compare its current value and the repair costs. If repair costs are less than the value of equipment, it is best to get it repaired. However, when the repair costs exceed the value of equipment, it is better to replace it.

 The above interpretations are absolutely personal in nature and are not binding on any individual/ organization in particular.