The question of whether the value of inventory should be taken into account in a company valuation is a frequently discussed topic. The warehouse is an important feature of the business and significantly influences the financial health and operations of a company.
Three schools of thought on how to handle inventory in a sale:
- No payment for the warehouse: The argument here is that the warehouse is already included in the company’s overall performance. Companies are often valued based on their profit or sales, and the warehouse plays a central role in generating that profit or sales. Therefore, it should not be evaluated separately.
- Additional Payment for Excess Inventory: This school of thought holds that only inventory in excess of the normalized net value should be paid in addition to the value of the business.
- Warehouse as an important asset: Here, the warehouse is considered as one of the key assets in a company’s asset sale and is valued separately.
Practice from the buyer’s perspective
In practice, buyers tend to take a conservative stance when it comes to valuing inventory. They often favor the first or second school of thought, especially if the warehouse is not viewed as the company’s primary asset. This is because buyers want to minimize the risk of paying for assets that may not deliver the expected value. However, for businesses where inventory represents a significant portion of the total value, the third school of thought can be applied to ensure that all assets are valued appropriately.
Recommendations for handling inventory value
- Quick/rough appraisal: When doing a quick or rough appraisal, it may make sense to ignore the warehouse to simplify and speed up the appraisal process (we use this method for our online appraisal ).
- Comparing Inventory Value and Goodwill: If the value of inventory exceeds the goodwill calculated using earnings, sales, or market method, this could indicate that the valuation method should be adjusted.
- Inventory fluctuations: It is important to consider whether the inventory at the time of assessment is significantly higher or lower than average. Unusual fluctuations should be taken into account in the assessment.
These recommendations are intended to help business owners and buyers make an informed decision about the treatment of inventory value in business valuation.