Small Business Today Magazine MAY 2014 CUSTOMIZED REAL STATE SERVICES | Page 23

EDITORIALFEATURE

Inventory... Should it Be Included or Excluded

When Buying or Selling a Business?
By Jeffrey D. Jones, ASA, CBA, CBI

I

nventory is a tangible operating asset of a business
just like the other operating
assets needed to generate
revenues and earnings.  Some
businesses are equipment
heavy and others are people
heavy.  In valuing a business,
we don’t determine their value without the equipment or
without the people and then
somehow add the value of
these items to the price of the
business.  Yet, some business
owners expect a buyer to pay
a value for their business without the inventory and then add
whatever inventory is on hand
at closing as an additional cost.

The fair market value of
any businesses is based on
the concept of providing the
owner with economic benefits. 
First, there should be sufficient
earnings to pay the owner a
reasonable salary.  Next, the
earnings should be sufficient
to provide a reasonable return on all the tangible assets
(including inventory) necessary
to operate the business.  Any
remaining earnings are a result
of the intangible assets such
as goodwill. It is impossible to
accurately determine the value
of a business without knowing
the full extent of the required
investment needed to produce
the expected level of earnings. 
 Use of the “add on” inventory method is justified by
business owners and some
business brokers based on the

Average Daily Inventory - This

Many businesses with inventory do not
experience great variations in the
amount on hand throughout the year. 
concept that inventory will often fluctuate throughout the
year.  So, rather than try to determine the amount of inventory needed to support the
reported revenue and earnings, they add it based on whatever it is at the time of closing. 
This method greatly increases
the risk that for any given business the inventory at closing
may not be the normalized
amount needed to support
the revenue and earnings thus
requiring the buyer to pony up
additional funds within a few
days or months to adequately support the busine