Why Should Inventory and Accounts Receivable be Part of the Purchase Price?

Why should Inventory and Accounts Receivable be Part of the Purchase Price?

The standard procedure when a broker takes a listing, on a small main street business, can be with or without the inventory being included in the listing price. Including it actually presents a more honest picture, to the buyer, of what is required to buy and run the business. The reason it gives a better picture, with the inventory included, to a buyer, is because when the buyer looks at the net cash flow figure (SDE) and then compares it with the asking price, the buyer sees that it a high multiple. Let’s take an example. Net cash flow is $100,000. The price without inventory is $200,000 and with inventory is $300,000. The price is 2 x without inventory but 3 x with inventory. This might make the asking price look too high but in fact that is the real multiple.

Read the full article to find out why this is so important.

The purchase price of any business must include all assets necessary to produce and sell the product.

Furniture, fixtures, and trucks are all necessary to doing business. These items can’t be left out or be added as additional buyer costs, because the inventory IS the product itself. The accounting concept that inventory is not required to produce the product because it is the product, throws a small confusion into the subject, which is why it is sometimes not included in the price.

Accounts receivable is another similar issue and should be included in the purchase price because it is required to finance the buyers purchase or there would be no purchase. If standard financing is 30 days, then it is part of the sales expense. May sellers try to keep the accounts receivable and let the buyer finance his own accounts receivable. This is part of the operating expenses of the business and really needs to be part of the total purchase price along with the inventory and equipment.

My suggestion is to consider what the total purchase price will be with the inventory and the accounts receivable both included.

If the listing price has either of these excluded, it is of no importance, because you as a buyer can just include them for all your financial calculations. You are buying a going business, not starting a new one. Working capital is part of the investment needed to buy and operate the business.

Look at the viability of the business regardless of how the purchase price is structured. If you buy the business without the Accounts Receivables you must invest that much more money into the business.

I have seen businesses that are making a profit each year but the price is way too high when everything was included in the total price. The business owner had not taken these issues into account when figuring the available profit. There was none. All his profit went back into the business and paying his SBA loan payment. The only way he would keep his reward was to wait 10 years when the SBA loan was paid off or sell the business and get his investment and invested profit back. None of this was obvious to the prospective buyers looking at this business making a taxable profit.

Summary:

How the listing is structured is not important. What is important is that a prospective buyer and the seller look at the total cost to a buyer including furniture, fixtures, vehicles, inventory and accounts receivable. Determine a negotiated purchase price taking all these factors into account and have a win- win deal.