Appraisal of Inventory

Transcription

1 Appraisal of Inventory

2 Why Would Someone Want to Value Inventory? Financial Reporting Federal Tax Purposes Property Taxes (Ad Valorem) Asset Based Lending (ABL)

3 Definitions of Value The purpose of the appraisal usually determines the definition of value. The typical value for financial reporting is Fair Value. The typical value for federal tax reporting is Fair Market Value. The definition of value for asset based lending is usually Net Orderly Liquidation Value or Net Forced Liquidation Value. Property tax valuation definitions vary by jurisdiction. Classified as Tangible Personal Property or TPP.

4 Definitions of Value Fair Value The amount at which an asset (or liability) could be bought (or incurred) or sold (or settled) in a current transaction between willing parties, that is, other than a forced or liquidation sale. Fair Market Value An opinion expressed in terms of money, at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts, as of a specific date. Orderly Liquidation Value An opinion of the gross amount, expressed in terms of money, that typically could be realized from a liquidation sale, given a reasonable period of time to find a purchaser (or purchasers), with the seller being compelled to sell on an as-is, where-is basis, over a defined period of time. (Lenders sometimes have their own definition). Forced Liquidation Value An opinion of the gross amount, expressed in terms of money, that typically could be realized from a properly advertised and conducted public auction, with the seller being compelled to sell with a sense of immediacy on an as-is, where-is basis, as of a specific date.

5 What is Inventory? Both U.S. GAAP and IFRSs define inventories as assets that are (1) held for sale in the ordinary course of business, (2) used in the process of production for sale, or (3) materials or supplies to be consumed in the production of inventory or in the rendering of services. The cost of inventory under both U.S. GAAP and IFRSs generally includes direct expenditures of getting inventories ready for sale, including overhead and other costs attributable to the purchase or production of inventory. * The term inventory is defined in ASC and paragraph 6 of IAS 2.

6 Summary of Types/Categories of Finished Goods: Inventory Inventory held for sale in the ordinary course of business Work In Process: Raw Materials: Inventory in process of production for such sale Inventory to be currently consumed in the production of goods or services to be available for sale. *FASB ASC Inventory

7 Do two similar inventories (from different companies) always have the same value?

8 Inventory Management At the most basic level, inventory can be tracked at a dollar value, by increasing the value of inventory on hand by the amount of purchases and decreasing it by the dollar value of the cost of goods sold. A company will typically maintain a perpetual inventory report which indicates the quantity and carrying cost of the on-hand inventory, on a SKU by SKU basis. An inventory appraiser analyzes not only how inventory is decremented from the perpetual report but also the reporting capabilities and accuracy of the reports provided for review.

9 Why is the bifurcation of inventory important?

10 Grouping (Bifurcation) When valuing the inventory on a SKU by SKU basis it is necessary to regroup the inventory into meaningful buckets (sub-categories). This allows the appraiser to analyze the inventory mix and cumulative percentages of value by category.

11 Costing of Inventory

12 Methods of Costing FIFO (First In First Out) LIFO (Last In First Out) Standard Cost Moving Average Cost

13 Why is Inventory Costing Important? How companies account for inventory affects how they measure profitability. Depending on the method of accounting for an item, a specific selling price may result in a different gross margin. Depending on how they account for inventory, the cost basis of what is left in inventory may not be the same as the cost basis of what was sold. Inventory values are typically reported as a percentage of cost.

14 Lower of Cost or Market Where there is evidence that the utility of goods, in their disposal in the ordinary course of business, will be less than cost, whether due to physical deterioration, obsolescence, changes in price levels, or other causes, the difference shall be recognized as a loss of the current period. This is generally accomplished by stating such goods at a lower level commonly designated as market value.

15 Lower of Cost or Market (Cont d) Lower of Cost or Market is a valuation rule based on conservatism. Specific inventory items are written down to reflect a loss in value from the current carrying cost. In the opposite case (unrealized gain), no accounting recognition is given.

16 Commodities and Market Pricing Inventory appraisers should compare a company s current carrying costs to the current market prices for their commodities. Companies who purchase commodities usually subscribe to trade market publications. Assessing the carrying cost and reflecting the value of the inventory compared to the current market price is called Mark to Market. Appraisal values should not exceed current market prices.

17 Examples of Trade Publications Urner Barry - Seafood, Meat, Poultry Metal Prices Ferrous, Non-ferrous, scrap metals Poten & Partners Asphalt, crude oil, liquefied petroleum gas, LNG & natural gas, naphtha Random Lengths Dimensional Lumber, Various Wood products and species 17

18 Units of Measure An appraiser needs to understand units of measure for on hand inventory compared to units of measure for inventory sold through the course of business. In order to value the inventory you must first quantify what you intend to value.

19 Board Feet Example (MBF to Extended Cost) Description Units on Hand On Hand Unit of Measure Weighted Average Cost Cost Unit of Measure Extended Cost of Inventory 2" x 6" x 16' DF 2 BTR Borate.25 (Dimensional Lumber) 9 PC $1, MBF? Process Calculations Total Cubic Inches for 1 Piece of Inventory 2304 (2*6*(16*12)) Total Units on Hand 9 Total Cubic Inches for SKU Board Feet (Total Cubic Inches per Board Feet) 144 Cost Per Board Feet (MBF/1000) $ ($1,057.75/1000) Extended Cost (BF*Cost Per BF) $ (20736/144)*$

20 Why Conduct a Site Visit? Site visits are conducted because there are certain types of information that cannot be obtained in any other way (inventory condition, existence, plant operations, category understanding, nomenclature, etc.). A site visit also allows the appraiser to test the veracity of management s claims.

21 Site Visit Objectives Understand how the business operates as a going concern. Understand how inventory is received, stored and sold through. Identify any factors which may affect the value of the inventory. Validate electronic inventory reports.

22 Valuation for Asset Based Lending

23 Asset Based Lending Asset Based Lending is a business loan secured by collateral (assets). Inventory, Accounts Receivables, Purchase Orders, M&E Inventory is a critical component of the loan structure. Inventory is typically valued at the net recoverable value (NOLV or NFLV) and presented as a percentage of cost. The appraisal value often times establishes the advance rate against the inventory, as well as an inventory ineligibles which the lender should not utilize as collateral.

24 Borrowing Base Certificate A borrowing base certificate is an asset accounting document that the borrower periodically provides to the lender that determines how much they can borrow against their inventory. Because inventory levels are changing constantly, the amount that a company may borrow against their inventory also changes constantly.

25 Turns Analysis Method of analyzing the inventory on a SKU by SKU basis. Units on Hand/((Units Sold in Prior 12 Months + Units Used in Production in Prior 12 Months + Pending Open Orders to be Fulfilled Through Duration of Proposed Time-Frame)/12 Months Sales History) = Months on Hand In theory, inventory which is selling through more quickly has a greater inherent value compared to inventory which is selling more slowly.

26 Factors/Variables Considered when Valuing Inventory Mix of Inventory Absorption Inventory on Hand vs. Open Orders Margin Selling Terms Private Label Returns/Stock Balancing Distribution Chain E-Commerce Seasonality Royalty Payments Co-op Payments and Accruals Drop Shipments Customer Concentrations Markdown Allowances Minimums On-Hands Inventory Concentrations Shelf Life vs Useful Life Passive Sales Consignment Guaranteed Sales

27 Assuming proper storage conditions, what one factor impacts the shelf life for all the following types of inventory? Dimensional Lumber Outside Storage Yard Rolled and Sheet Metal Interior Facility Storage Tires Interior Facility Storage Hardwood Flooring Interior Facility Storage Frozen Food Cold Storage facility 27

28 Conclusion Ultimately, the appraiser s job is to mitigate risk. Understand the variables that can affect the value. Provide logical conclusions based on real-world scenarios. At the end of the day it comes down to the loaded question what is the inventory worth?.