Inventory Valuation

Sep 30, 2014

The valuation of the inventory and work in process in a mergers & acquisition transaction involving a manufacturing company is a sophisticated process.  The process requires experience, knowledge, and the business acumen to look at an individual component from cost and return on investment perspectives to determine what a “fair” valuation would be in the situation.   The valuation should incorporate materials, labor, overhead, liquidity, and the time value of money.   

An interesting case example for conceptualizing the value of inventory in a manufacturing context is a winery.  A winery this time of year will have grapes on the vine awaiting harvest, raw materials at the winery (grapes & bottles), juice in tanks, wine in barrels, and wine in bottles.   The value of the raw materials will be their cost.  The value of juice in tanks will potentially include a load for labor & overhead above the cost of the raw materials.  The value of the wine in barrels will have a higher value than the juice fermenting in tanks.  Arguments can be made for including barrels in furniture, fixtures, and equipment or inventory.    The value of a barrel, a depreciating asset for a winery, starts with its cost, often including a load for shipping cost, and depreciates to the market value achievable when sold for a secondary use.  The value of the wine in bottles should incorporate the venue employed to sell the product.   Small production wineries selling direct to consumers will justify a higher transactional value for their bottled wine than wineries selling product through distributors or to large format retailers.  The governing concept when valuing inventory is can the purchaser make a reasonable profit when the inventory is sold given their acquisition cost, carrying expenses, and the liquidity of the product.

The final valuation of inventory occurs in close proximity to the closing date for the transaction.  It is recommended in a professionally facilitated transaction to have a preliminary inventory value established and recognized by the parties early in the sale process.   It is common for the negotiation of value for inventory to be confrontational, as the seller wants a highest possible value and the buyer wants to avoid inheriting problems (e.g., a poor vintage with liquidity issues) or over paying from a return on investment perspective.   An experienced facilitator can serve as a trusted guide through the inventory valuation process minimizing confrontation and maintaining transactional goodwill.

IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media and the mergers & acquisitions community on how to value inventory in a transactional context and any other subjects relevant to the purchase & sale of a business.