A well organized kitchen makes a big difference to a restaurant. A manufacturing firm has production equipment that is fine-tuned to reduce costs and output quality products.
Needless to say, such special-purpose assets are very valuable because of their essential contribution to business earnings.
Challenges in valuing specialized business assets: highest and best use
Yet valuing such business assets may be harder than it seems. The need to value business assets often arises when the business comes up for sale. The key question then is whether the business buyer intends to continue using the specialized assets for the same purpose.
If, for example, the business buyer plans to make operational changes, some special-purpose assets may require additional investment. If the buyer uses the cost approach to valuing these assets, their business value will be adjusted net of the expected additional outlays.
Put differently, the business buyer may not be putting the specialized assets to their “highest and best use”.
Fair market value of special-purpose business assets
Since savvy business sellers and buyers tend to act in their best interests, specialized business assets do have fair market value. The reason: in the business market, there are alternatives.
What this means is that you are unlikely to spend more on an asset than the cost of a suitable alternative. If you are selling a business, you would consider several offers before making a decision.
Alternatives, business value and the principle of substitution
This principle of substitution is a powerful economic force that influences the value of businesses and their assets.
Unique assets and amazing valuations
If the asset is truly unique, the principle no longer applies. That’s one reason why works of art can command such unexpectedly high valuations.
Business assets and commercial property are not really unique – there is always the next best thing that will do. Existence of reasonable alternatives explains why values of business assets tend to gravitate toward the fair market value equilibrium.