| If you are preparing your business for sale – a company which, no doubt, you will have built up with sweat and tears over years, if not decades – then you will already have had some thoughts about how much it is worth. Valuing a business is a complex affair, and requires in-depth analysis of company accounts, leases, contracts, prospects, and so on. But one area that can often complicate the whole process is stock – and that means raw materials and work in progress as well as finished goods. Stock is a particular issue in businesses that are stock-driven, says Mike Halls, Managing Director of merger and acquisition specialist Beer Mergers. Classic examples are mostly in the retail sector; Halls gives the examples of stationers or wine merchants. SAV, goodwill and more “If it’s a small business, it will be sold on the basis of a goodwill payment plus Stock at Valuation (SAV),” he says. “A specialist firm of valuers would normally be called in to independently compare the stock with the value quoted on the balance sheet. “Depending on how robust the business’s annual audit and stock valuation systems are, there can be quite a material difference – because of obsolescence, depreciation and basic ‘shrinkage’. “Nonetheless, for these types of businesses it is a fundamental principle that whatever the independent valuation shows will be the basis of the sale irrespective of the balance sheet value, which is notional and historic.” But Halls cautions that this formula does not apply to many other types of business. Stock, he says, like other assets, is regarded purely as a tool for the production of profits. It is not viewed as having any intrinsic value in itself. “The value of the business and the sale deal will be based on a multiple of profitability,” he adds. “The difference between that figure and the net asset value in the balance sheet, including whatever stocks there are, will be the ‘goodwill’ – which will vary according to the type of company.” In those types of deals, he says, the individual working assets, from computer equipment to fixtures and fittings, will not be separately valued. Instead, their balance sheet value will be checked through normal due diligence, and not modified unless there is a major discrepancy. Valuation Accounting standard SSAP 9 (statement of standard accountancy practice) gives some insight into how valuation of stock should occur. It states that stock should be valued at whatever is the lowest of cost and net realisable value. It states that cost is “that expenditure which has been incurred in the normal course of business in bringing the product or service to its present location and condition.” For a wine retailer, for example, that will consist of the cost of a bottle together with the cost of getting the bottle to your shop. If, on the other hand, you sell hand-made jewellery or furniture, the cost will be a rather more complicated calculation. You will have to examine the cost of materials, add the labour cost for the units in question, and add on expenses and overheads incurred while the project is manufactured. Net realisable value is easier. It is simply how much the stock can be sold for, less any other outgoings you have before making a sale. There are a handful of methods to arrive at a figure – and the most obvious is on an average cost basis. You can calculate this by adding together the costs associated with the first item to arrive and be sold and the last item to arrive and be sold – which will usually represent the largest and smallest individual profits – and dividing the total by two. Depreciation Another is by applying the standard accountancy technique of depreciation. This is usually applied more to operation assets than stock, but if your business either has a low turnover (for example a car showroom), or the stock itself is prone to redundancy (an electronics business perhaps), then depreciation becomes quite important. In this context, it measures how the value of stock reduces over time. To calculate depreciation, you need to estimate how much an item of stock is worth at the end of its lifespan – i.e., when you are certain it can no longer be sold, what is it disposal value? This may be zero, of course, but in the case of a piece of electronic goods, for example, it could derive value from being sold as parts or scrap metal. You then need to deduct the cost of storing and selling it. You should then deduct the resulting figure from its value if it were sold on day one (again, this will be the price paid minus the costs involved in selling or delivering it). The figure you arrive at is the total depreciation over its lifespan. You will have to divide this by the time it can feasibly be kept in stock to get a figure of depreciation per week, month or year – whichever is most appropriate in your business. You can then use this figure to calculate the value of your total stock based upon how long it has been held. Stock isn’t always relevant Of course, for many businesses – for example, an estate agency – stock is not a relevant concept. For others, such as a clothing retailer, stock is of relatively low value but is turned over very frequently. Buyers will be far more interested in location, turnover and level of sales. But if the stock itself is a valuable part of the business, it is worth having a rough idea of how much it is worth before negotiating with buyers. Be aware, too, of the complicated tax arrangements regarding stock sold as part of a business – a topic that is, sadly, beyond the scope of this article. | 
