Commercial replacement cost and actual cash value are terms that usually come up in discussions about business insurance. According to the Insurance Information Institute, 25 percent of all businesses that experience a disaster never open their doors again, so it pays to properly insure a business. However, these two terms are also important when determining the market price of an operating business.
The replacement cost of an item is the amount of money it would take to purchase an exact replacement of the item if it were lost or destroyed. This is what it would cost to purchase the item on the open market. With buildings, it is the amount that it would take to rebuild a structure to its exact condition. Replacement cost also is a factor in calculating the actual cash value of an item.
Actual Cash Value
Actual cash value is the amount of money that an item or piece of property would sell for on the open market in its present condition. It accounts for the depreciation of an item due to age or wear and tear. Actual cash value may be based on what the item would bring if sold at auction at a quick sale, or if it were sold at retail under ideal conditions. It may vary considerably based on which of these two methods is used.
Commercial replacement cost and actual cash value are commonly used by insurance companies in determining the amount of coverage an insurance policy provides. An insurance policy may default to actual cash value coverage unless the buyer expresses that he wants to upgrade his policy to cover replacement costs. A replacement cost policy will be more expensive due to the increased coverage, but it will often provide for quicker resumption of business operations because the destroyed property is replaced with new property without draining the owner's capital.
If you are selling or buying a business, these two terms are a factor in determining value. Many people are not willing to pay more than the actual cash value for a business, which is difficult to determine. When determining the market value of the business, the entrepreneur must consider what it would cost him to purchase all of the items if he were to start the venture from nothing. The convenience of having all of these items together in one place, ready to produce income, coupled with other business intangibles such as goodwill, can lead a person to pay more than the actual cash value of the business assets to purchase the business.
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