This is most likely not the first time a professional who is involved in business sales and acquisitions has contemplated this question. While most valuation and recasting elements of our profession are very straightforward, how inventory is incorporated in a valuation and business sale can vary considerably. This is an issue where the phrase “it depends” is appropriate.
It’s probably appropriate to define “inventory” as it’s referred to in this article. “Inventory” is defined as saleable goods purchased by the business for resale. However, when considering the definition of owner benefit or seller discretionary cash flow the AMOUNT of inventory expected to be included is the amount of inventory that was required to generate the profits being represented.
This raises an interesting, double-edged, point. How do we know if there is an excessive amount of inventory? How do we know if there is a shortage of inventory? The only way to start evaluating this issue is to start with the balance sheets looking at beginning and ending inventory values. If there is less inventory at the end of the period, profit is likely over stated (because cash was not re-invested into inventory). If ending inventory is higher than beginning inventory profits are […]