Valuing Inventory – The Dilemma

When you sell a business, invariably, one of the most often asked questions are about inventory. The issue is that most business owners don’t understand how their inventory is to be ‘valued’ by a buyer.

The truth is that there are many ways to look at inventory value. You can say its worth what you paid for it (option 1), or what it is worth today (option 2), or what it should be to continue to run your business efficiently (option 3). these are three options you should consider.

Option 1 seems simple. You buy 1,000 widgets for $1.00 a piece, so logically, it should be worth $1,000, right? What about freight? What happens if you are a manufacturer, and some of your inventory is now in work-in-process? Does it also include the labor cost? These are not only good questions, but sometimes difficult to answer given the variations in business operations.

Option 2 seems somewhat illogical, but you do need to recognize the possibility that variations to inventory can be occurring. Take, for instance the value of highly commoditized stock, like computer memory. You could buy a 1GB inventory chip for $32/each per lot of 100 on a Thursday, and by Monday it may be worth $31.65/each per lot of 100. Since accounting rules require you to value assets at the lower of cost or market, do you continually revalue the inventory to have accurate financial statements? Likely no, but you can be assured that a buyer is NOT going to pay you for inventory that highly fluctuates for a value worth more than it is on the day of closing.

In option 3, you need to be aware of what is necessary to adequately run your business, and maintain it as a ‘going concern’. Although the rationale and details behind this are beyond the scope of this article, consider that many business owners and purchasing managers buy inventory and raw goods that are NOT in optimal quantities. For example, the business owner who purchases 1,000 widgets because he ‘received a  great price’ may make some sense, but on the day they sell the business, the buyer may only NEED 200 to keep the business running well. How much is the excess 800 units worth in that case?

These questions, and a myriad more exist. The challenge is to prepare your business to ensure that you receive the optimal value for your inventory.

Need to know your options, and how to handle it? Speak to an intermediary at Calder Associates that is well versed in inventory and tax requirements who can review the issues YOUR company faces. Get an idea of what is valuable in the marketplace and your role in achieving the greatest return.

About the broker blog

The Blogger- Steve Wain

Steve is the President of Calder Associates, and the past Chairman of the International Business Brokers Association, and President and Founder of the Mid-Atlantic Business Brokers Association. A professional whose owned and sold a number of businesses in the past, Steve provides expertise to many business owners and buyers.