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Insuring Your Business’s Property? Consider a Replacement Cost Analysis

Insuring Your Business’s Property Consider a Replacement Cost AnalysisIf their property happens to be destroyed or damaged, businesses must take on a replacement cost to replace essential assets at the same or equal value. The asset to be replaced could be a building, investment securities, accounts receivable or liens. Replacing an asset can be an expensive decision, and companies analyze the net present value (NPV) of the future cash inflows and outflows to make purchasing decisions. Once an asset is purchased, the company determines a useful life for the asset and depreciates the asset’s cost over the useful life.

This process can be very overwhelming for businesses. Fortunately, a replacement cost analysis can help your business to determine what your replacement cost is and how you can cover it.

Understanding Replacement Costs

As part of the process of determining what asset is in need of replacement and what the value of the asset is, companies use the process of NPV. To make a decision about an expensive asset purchase, companies first decide on a discount rate, which is an assumption about a minimum rate of return on any company investment.

Then cash outflow for the purchase and cash inflows based on the increased productivity of using a new and more productive asset are considered. The cash inflows and outflows are adjusted to present value using the discount rate, and if the net total of all present values is a positive amount, the company makes the purchase.

The replacement cost adapts to market value fluctuations of the particular asset and any other costs required to prepare the asset for use. 

When insuring a business property, it’s critical that you determine accurate and up-to-date values that reflect the cost to repair or replace an asset in the event of a loss, such as fire or a natural disaster, that applies to the physical property and the contents inside your business. It’s important to have an insurance program that accurately reflects the values of your property with a Replacement Cost Analysis, which we offer as part of our business insurance products.

Special Considerations

When calculating the replacement cost of an asset, your business will account for depreciation costs and capitalizes an asset purchase by posting the cost of a new asset to an asset account. The asset account is depreciated over the asset’s useful life and will match revenue earned by using the asset with the expense of using the asset over time. 

Some assets are depreciated on a straight-line basis (asset cost is divided by the useful life to determine the annual depreciation amount), while others depreciate on an accelerated basis (more depreciation is recognized in the early years and less in later years). The total depreciation expense recognized over the asset’s useful life is the same, regardless of which method is used.

Budgeting

Given the cost of replacing expensive assets, well-managed firms create a capital expenditure budget to plan for both future asset purchases and for how the firm will generate cash inflows to pay for the new assets. Budgeting for asset purchases is critical since asset replacement is required to operate the business. A manufacturer, for example, budgets for equipment and machine replacement, and a retailer budgets to update the look of each store.

About AJ Benet Insurance Agency

At AJ Benet Inc. Insurance Agency, we make sure that your New York Business Insurance policy includes more than the simple general liability and product liability. Our policies extend in cases where your underlying limits are exhausted. Our team of experts is willing to go the extra mile and not only protect your business but understand it. For more information, call us today at (914) 381-2040.

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