07 Mar Is Inventory Included in the Final Value?
Is Inventory Included in the Final Value?
(6-7 minute read)
An SBA compliant business valuation should reflect the structure of the proposed purchase terms. If the subject company is a retailer/wholesaler or any business that carries significant inventory, an Asset Purchase will typically be structured as either:
Purchase Price including Inventory
Purchase Price plus Inventory
A Stock Purchase structure will typically include all inventory (as well as all other assets and liabilities).
If the purchase price includes inventory, the business valuation should include inventory as well. If inventory is in addition to the purchase price (i.e. inventory value will be determined at closing and purchased separately), the business valuation should not include inventory. Simply put, this is like comparing “apples to apples”.
In determining the final value, the Appraiser will analyze a Market Approach, based on taking valuation multiples from actual closed comparable transactions, and adjusting and applying those multiples to the subject business being valued.
In analyzing the Market Approach it is important to know if those comparable transaction multiples are derived from purchase prices including or excluding inventory.
Inventory Excluded From Multiple
Take a look at Sample #2 above, which sold for $420,000 (with $300,000 of Inventory sold in addition to the purchase price). Based on $120,000 of SDE, this comes to a Price to SDE multiple of 3.5x. Now let’s look at the database again, this time if multiples were calculated based on purchase prices that included inventory:
Inventory Included In Multiple
Under this way of calculating multiples, Sample #2 with a purchase price of $720,000 including inventory has a Price to SDE multiple of 6.0x. In fact, Sample #1 in the table above now has a lower multiple than Sample #2, despite being the stronger business – solely because Sample #2 carries a higher inventory balance. This shows that when the market approach is calculated with inventory included in the database transaction purchase prices, the valuation multiples are heavily impacted by the amount of inventory held by each company, and it is important to note that not every company will maintain similar inventory levels.
Depending on the industry type, a business’s inventory balance could change month to month based on demand and seasonality. For example, a liquor store stocks up extra inventory the week before most holidays. Including the inventory in the purchase price used to calculate valuation multiple would under-value or over-value the liquor store significantly, or any inventory-heavy retail business for that matter, depending on when the inventory level was calculated (typically, the date of the interim balance sheet rather than the closing date).