How to Value Inventory when Buying a Business




Buying a business can be a complicated process.  There are many areas that may cause the failure of purchase negotiations or cause animosity between the seller and buyer.  One such area is the valuation of the business.  Determining the worth of a business is a crucial and critical aspect of the buying process.  If you buy a business that is overvalued, you are paying more than what the business is worth.  On the contrary, if you buy a business that is undervalued, you will wonder if the business is failing.

Take the case of valuing the inventory of a business for sale.  What should you include in the inventory?  What valuation method should you use? In most industries, the value of inventory is above the asking price of the business for sale.  Here are some pointers on How to Value Inventory:

1.  The potential buyer and seller should agree on which valuation method to use for inventory.  This could be by using a) the original purchase price or vendor’s invoice, or b) the current value of the items.   The latter is the simpler and more realistic method.  Using the original purchase price may not reflect the actual value of the assets.

2.  The final count and valuation of the inventory should be done at the close of the sale, since the amount of inventory during the purchase process is usually different. 

3.  There should be an anticipated value for the inventory between the seller and buyer.  This value will more or less reflect the closing value of the inventory, which will be adjusted accordingly.  This is done to avoid disagreement between the two parties.  This will also ensure that the buyer has some inventory sufficient for a few months’ worth of operations when he or she takes over the business. 

4.  If you are not sure which particular items can be valued as inventory, consult an accountant.  Inventory includes products and materials that can be resold or used in servicing a client.  Inventory is different from other hard assets such as machineries, equipment and furniture. 

5.  The buyer must insist on the physical count of the inventory.  The business may have inventory control software but because of input errors, glitches or unaccounted losses, there may be some discrepancy with the actual inventory. 

6.  Determine the quality and condition of the items – which items are saleable and should be included in the valuation.  You can negotiate items that are difficult to sell, such as those no longer in demand, should be valued for half the cost.  Other items that if you feel are not in line with what you want to sell or not compatible with your target market could be excluded from the valuation. 

7.  If you and the seller have a friendly relationship, you can conduct the inventory count together, or at least a part of it.  This will be time well spent for you as the seller can explain some aspects of the business during this time.

8.  Bring in an outside inventory service firm that will count the items, determine the cost and calculate the value of the inventory.  This is a wise move especially if there is some animosity between the buyer and seller, or if the seller and buyer do not want to take the time and energy to count the inventory themselves.

Valuing inventory is important.  You or a qualified representative should be present during the examination of the inventory.  Knowing the status of inventory and what is available will apprise you of its value.  If you do not agree to the price tag set by the seller, negotiate.  Does the inventory valuation make sense to you?

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