Stock value when selling a business
The policies you use to value your inventory can be important when selling your company.
If your business holds significant amounts of stock, you have probably had conversations with your auditors about how to value it on the balance sheet in your statutory accounts. The approach you take to valuing inventory can also be important when it comes to selling your business.
Why stock policies matter
Accounting regulations require that stock is valued at the lower of its cost or its net realisable value. Net realisable value is defined as the market value of the products, less the costs associated with selling them.
Whilst this is a fairly simple rule, for some businesses the process of determining net realisable value can be complicated and is likely to involve some subjective judgements. A more conservative approach will reduce the value of the balance sheet, matched by a downward adjustment in profit for the year. By contrast, an overly optimistic assessment of the value of inventory could mean that both profit and balance sheet values are overstated.
How stock can change the value of your business
Of course, your stock valuation process only results in accounting adjustments and has no impact on cash flows.
But when you are selling your business it is often your profit (commonly EBITDA) that is factored into the buyer’s valuation methodology. If your business-as-usual mentality is to take a highly conservative approach to stock valuation, your profits (and therefore ultimately the value of your business) could end up being understated.
To put this into perspective, if you hope to sell your business for 8x EBITDA, impairing your estimated stock value by just £125,000 could cost you £1 million of sale proceeds.
Furthermore, when you sell your company the buyer will often require you to leave a certain level of working capital in the business at the time of completion. Because inventory forms part of the working capital equation, conservatively undervaluing your stock could result in you having to leave more cash on the balance sheet.
What will a buyer be looking for?
You can expect an experienced buyer to act rationally and seek to avoid the risk of overpaying for a business. They will scrutinise your valuation policy and analyse your inventory lists, taking their own view on whether there are items that should have their value reduced or written off.
They will assess the fairness of your approach by looking at how quickly stock has turned over in the past, and by comparing the valuation and provisioning policies with those used in their own business or with accepted industry norms.
What to do about inventory valuations before selling your company
Before negotiations with a buyer start, it’s a good idea to review the age and quality of your stock and consider whether your existing approach to valuation been sufficiently fair and accurate. It is also important to make sure that the data you hold on your inventory is well organised and robust, since the buyer will need to review it as the sale process progresses. Making sure your inventory valuation is well thought through and defensible will make negotiations much easier further down the line.
Want to know more?
If you have concerns or questions about your own inventory, please do not hesitate to get in touch. We would be delighted to hear about your business and share our experiences of how other companies in your sector have approached stock valuation.