I am In The Process Of Buying A Retail Store - At What Point In Time Does One Perform The Inventory Process And Get The Final Numbers In Escrow? Any Other Tips About The Inventory Process I Should Know About?
Whether selling big ticket or low ticket items, Inventory is the life blood of any retail business and often a significant percentage of the total consideration when purchasing a retail business. Buyers can expect to pay for Seller's (good) inventory at cost, dollar for dollar. When you write up the purchase agreement, make it clear what value of inventory is included in the price, and if the price will or will not change with the final value at closing. During your due diligence period you should take initial stock of the current inventory and get a good understanding of:
(a) the saleability of the inventory, how long has it been on the shelf?
(b) how quickly inventory turns
(c) how much you typically need to have on hand at any given time
(d) how much you want to take over when escrow closes. Often Sellers can control their orders during the escrow period (increase or decrease) to get the inventory level where the Buyer wants it.
(e) what system the Seller uses to keep track of inventory
(f) seller's process of ordering & delivery
(g) payment terms Seller has with his vendors (e.g. NET 30)
(h) how much if any is floored, on consignment or on layaway, and how much in initial deposits has already been collected by the Seller
Usually the Buyer is wise to continue what the Seller has been doing already successfully. The Final inventory count should be done after close of business, on the evening before Buyer takes possession of the business, or in the morning before opening. Often, the Buyer and Seller can determine and agree upon the total value together.
If needed, an outside company can be hired to take the final count and determine the value. Inform escrow of the final agreed-upon value. Finally, when you take possession of your new business the next day, don’t forget to bring change for the register and have your merchant account already setup and ready to go and enjoy the proceeds of your new business!
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Inventory should be taken as close to the closing of escrow as possible. Depending on the type of products a business sells, an inventory can take a few hours or days. It would be hard for a buyer to do the inventory as you would be unfamiliar with the inventory system. You would be relying on the seller to provide you the inventory list with enough time left before escrow closing to check it.
You must also understand that not all items on the list may be current salable products and there may be slow moving, obsolete or damaged items in the inventory. Make sure that the inventory list provided by the seller reflects these categories if any are present. Current salable inventory should be at buyer’s cost. Slow moving and other inventory should be at a discounted price or not included in the total inventory.
There are a number of ways you can check the inventory. If it is small you and the seller can look at each item. If there are many products and some are still packaged from suppliers you can spot check items listed on the inventory list. You can also hire an outside company that specializes in taking inventories.
The best time to do and check the inventory is after business hours the day before closing, but if this is not possible, a list of all sales or receipt of new good should be kept after the inventory completion and final adjustments to the list can be made just prior to closing.
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The ideal time to take inventory for a retail business is right before close of escrow. That way, the exact wholesale cost of the liquor and sodas, or shirts and slacks, or whatever merchandise is involved, can be supplied to the escrow holder and figured into the final payment and distribution of funds.
In some businesses, of course, it’s rather difficult to do that. There may be hundreds of dollars sold and/or brought in by suppliers between the time the inventory is conducted at a convenience store and the time scheduled for COE. In that case, to have the right figure, the parties will need to estimate how much the value of the inventory is likely to have changed since the count and tally was conducted.
One question to resolve is whether to hire an inventory service to conduct the count or have the principals count every item, determine its value, and then tally the totals to provide the final figure at escrow. If the relationship between buyer and seller is open and business like, it often is best for them to work together on this process. That can help form the relationship for the seller's training once the buyer takes over. And it’s an opportunity for the buyer to learn more about the business--exactly what merchandise is being sold and what it costs.
If the dynamics of negotiations has ruined the relationship between the principals, or there is a huge quantity of pieces and parts, it might be a better idea to engage a reliable inventory service to do the work. Typically, the bill for that work is divided equally between buyer and seller.
I've noticed that the way parties conduct inventory can reveal how smoothly things went during negotiations. If they got along and learned to respect one another, they may take shortcuts. That means the seller will offer to "throw in" extra merchandise rather than having to count it. And the buyer will be willing to pay for a whole shipment of items, even though a few have been removed from the carton and sold.
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The dreaded inventory count—buyers and sellers often would love to avoid it; but, in most transactions involving commodities (e.g., retail, distribution, food, manufacturing), it is essential. The contract may require the inventory to be paid for separately or may include it in the purchase price within certain minimum and maximum parameters. And, for accounting and tax purposes, there should be an accurate inventory figure agreed to by both parties.
Yes, this means counting individual items and determining a cost basis for each. The cost can be determined by referring to actual invoices (and would usually include a pro-rata allocation of the "freight in") or by consulting supplier catalogs and/or price sheets. The contract should specify what basis will be used for valuing inventory; if it doesn't, this could be a problem (a potential "deal-breaker") during due diligence.
In some cases, sellers may suggest using their running computerized inventory count and valuation, and accepting it as accurate. My suggestion to buyers: "Trust, but verify." The buyer should do a count to be sure that they are paying for actual goods received at the right value; and, the seller’s inventory might not account for "shrinkage," and might be counting obsolete, damaged, or nonconforming goods.
But, the seller also should have an accurate count. Years ago, I was involved in the purchase of a manufacturing company for several hundred thousand dollars (when a dollar was worth a lot more). The seller did an inventory and it was then spot-checked by the buyer's CPA, to verify the actual count and cost basis. This company produced items for the Defense Department. During the first year after the purchase, the new owners repeatedly brought new IFBs and actual orders to the shop foreman for manufacture, and the foreman would say, "Oh, we already have that in inventory." But, it didn’t show up on the inventory conducted during the transfer of the business! In that first year, the new business owners recouped their entire cost of buying the company from inventory that the seller had lost track of and, therefore, received no compensation for. They essentially bought the business for nothing, to the seller’s detriment.
You asked about timing. Whether the purchase price includes the inventory or whether the inventory is to be paid for separately, I suggest that the inventory be completed and valued before the close of escrow to avoid any cause for disagreement (and possible litigation). If the inventory is completed days or even a couple of weeks before the closing, careful recordation of actual sales and receipt of incoming goods between the count and the closing can be used to accurately adjust the inventory on the very day of closing.
And then, who should conduct the count? While outside services are available, in my experience it’s best for the buyer and seller to take the inventory together. It can be a good learning and transition opportunity for the buyer, and can lead to immediate discussion and compromise about inventory value. If a conflict arises about cost or about including or excluding an item, a third party—the business broker, a CPA, a mediator, or some other professional—can help resolve the matter.
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There is only one proper time to count inventory on any type of business sale. It is at the close of escrow just before the buyer takes possession of the new business. In either event; the purchase includes a set dollar amount of inventory or the purchase price is "plus inventory".
The reason for this timing is that a businesses inventory is an always changing amount. It is being used or consumed throughout each business day. If I were to count the inventory and convert it to a dollar amount any day other than the day the buyer takes possession of the business, the number would not be accurate on the day of take over. Leaving the buyer or sell short or in excess of what they really paid for.
When we know the day we are closing escrow and giving the buyer possession of the business, I like to schedule the inventory count either that evening before possession and after the business closes, or the same day of possession in the morning before the business opens. Obviously the night before possession or the morning of possession, depends on what type of business it is. If the business opens until late in the evening such as a bar, I like to take inventory in the morning of the day of possession and prior to the business opening. If the business opens earlier in the day and closes earlier as many service type business do, I prefer to take inventory after the business closes the night on the day before possession.
Additonally being prepared for taking inventory helps quicken and smooth out the process. Prepare a list of inventory items and most importantly get the cost of each item prior to taking inventory. It will make your life much easier.
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In the sale of a retail store the value of the Inventory can be a significant component of the total purchase price. At the time you make the offer you would have an estimated value of Inventory that is included in the purchase price. I recommend having a meeting one or two days before Closing date to conduct the inventory. The inventory can be done by Buyer/Seller together or you can engage a service that does it for you.
The price of the Inventory needs to be at cost (including any freight costs). Many times the cost value is arrived at by using the retail sale price and applying a factor that reflects the markup the business changes on average. For example if the Cost of Goods is 60% of Revenue, the you will take the retail value and multiply by 60% of that as the Cost. It is also important to make sure that the Inventory is current and saleable. I have used a rule that items should have sold in reasonable volume within the last six months or have been purchased during the past six months. This helps you eliminate items that have been sitting for a long time and are unlikely to sell in the near future.
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