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How Do You Value Your Inventory for An E-Commerce Business?

Reviewed By Ron Matheson

Written By Bill Gustin

Published June 23, 2019

Updated August 14, 2024

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How Do You Value Your Inventory for An E-Commerce Business?

Deciding how to approach the process of selling your e-commerce business can be overwhelming or even confusing if you don’t have the assistance of a knowledgeable website broker to guide you through. Inventory is no doubt required to run your business and you have probably established clear systems and processes to help you stay on top of all of that inventory.

It is frequently the case that you would include a normal level of inventory in the purchase price of your company when you decide to sell your e-commerce business. The primary purpose of this is to make a good faith effort to allow the business to sustain current revenues already being generated by the company.

This means that everything over this normal amount that you include in the purchase price has to be bought by the buyer in addition to the underlying business valuation. There are several different factors that must be incorporated in your consideration of your inventory cost, including:

  • Taking an inventory count and adjusting the sale price up or down prior to closing the sale with another party.
     
  • Valuing the inventory at cost. You also have the option of coping with an inventory amount that is higher than the normal level, which means that you might need to negotiate a price over that level.
     
  • Decide how the cost of the inventory will be factored into the sale using a percentage of retail price, the original invoice or a professional inventory firm.
     
  • Consider that not every piece of inventory is the same. Broken, aged or no longer in use inventory has to be evaluated individually to determine if it could be sold and the price for these items would need to be negotiated separately. Frequently, this occurs by discounting the portion of the inventory, but this can also happen when the seller finances a portion and then the buyer pays for these items when it sells.
     

There are many different factors you can incorporate into the process of fine tuning and tweaking your business to prepare it for sale. The following factors can significantly enhance the value of your business beyond the inventory and current sales;

  • Predictable drivers of new sales
     
  • A clean legal and financial history
     
  • A high percentage of repeat customers and sales
     
  • Traffic statistics that indicate a long history and regular traffic to your site
     
  • Reliable and established inventory suppliers with back up suppliers established
     
  • Potential for growth
     
  • Documented processes and systems that are not reliant on you as the business owner
     
  • A brand that has no legal, copyright or trademark concerns
     

Types of Inventory

The main types of inventory can be broken down into four categories:

  • Raw materials are the basic components that a company uses to manufacture and finish products.
  • Work-in-progress (WIP) includes all materials that your factory has begun working on but isn’t a finished product yet.
  • Finished products are ready to be released and sold in the market.
  • Maintenance, Repair and Operations (MRO) items are supplies that help create the product or maintain the business.
     

The Common Inventory Valuation Methods

Companies can choose from the main four inventory valuation methods for retail business. When it comes to how to value a business with inventory, key decision makers within the business should deliberate the pros and cons of every approach.

First In, First Out (FIFO method)

The first sets of products a business sells are the oldest inventory items it acquired, valuing inventory respectively. This widely used process aligns closely with actual inventory costs.

Older inventory is usually less expensive since material prices and other costs rise over time. As a result, using FIFO achieves a lower cost of goods sold (COGS) and a higher gross income compared to other valuation methods.

However, FIFO has two notable drawbacks. It comes with tax implications, as the company will need to pay higher taxes. Furthermore, FIFO can produce financial statements that may mislead investors during high-inflation periods.

Last In, First Out (LIFO method)

The FIFO and LIFO methods are complete opposites. Retail businesses that use the LIFO approach sell the most recent inventory.

Using the LIFO method tends to be the least profitable as the cost of goods sold (COGS) is based on the most recent (and likely more expensive due to inflation) inventory. Businesses that adopt this approach, however, will have lower tax burdens.

Weighted Average Cost (WAC)

The Weighted Average Cost (WAC) method calculates inventory costs based on an average of all inventory costs. It’s particularly useful for businesses with identical inventory items, as it simplifies the process by avoiding the need to track individual goods available for sale separately when figuring out gross profit and tax implications.

To get the weighted average cost per item, you have to divide the total cost of goods by the total inventory items.

Specific Identification

The Specific Identification method records every item from purchase to sale. This method isn’t ideal for retail businesses with a large quantity of goods available for sale. Instead, it’s the recommended approach for dealers of ultra-expensive, unique items.

Specific Identification offers the most accurate record of actual inventory costs and profits, allowing the company to gauge the profitability of every single item.

Choosing An Inventory Valuation: Which one is the best for your business?

For business owners this is one of the biggest questions: How do you value your inventory? The way to make the best decision is to establish your priorities and how every approach aligns with your goals.

The method of determining the value of inventory for a small business would be significantly different from that used by larger companies with more complex inventory systems. This is the

What truly matters is to stick with one method consistently, as this is crucial for both your business and IRS compliance.

You might often ponder the importance of inventory valuation for business and ask yourself: How is inventory valued on business valuation? But at the end of the day, it all depends on your priorities as an owner.

The Frequency of Recording Inventory

Businesses need to determine the frequency of recording inventory to have an overview of the stock levels of their products.

 

Annual Counting

This traditional method involves a full physical count of all inventory items once a year, which can be time-consuming and disruptive but provides a comprehensive snapshot of inventory levels.

Cycle Counting

This modern approach divides inventory into categories and counts different sections at various intervals throughout the year.

Perpetual Counting

This advanced method uses technology to continuously track and update inventory levels in real-time, but requires significant investment and maintenance.

How to Deal With Countless Products: Inventory Software Solutions

As the business expands, the problem of a business owner goes beyond deciding how to value business inventory. The countless items purchased will require a corresponding cost to each item to accurately calculate profits and tax liabilities. Tracking these finances with spreadsheets can quickly become overwhelming, time-consuming, and prone to errors.

Fortunately, leading financial management software can handle the most popular inventory valuation methods, automating the tracking and calculation of inventory costs. With inventory software solutions, you can achieve better accuracy, and your staff can focus on more valuable tasks.

Choose the Best Website Broker

When thinking about selling your business, partnering with an established e-commerce sales firm can help you to accomplish many of your sales goals. A website broker should be familiar with the common tactics used to arrive at multiples, how to list your company online for sale, and how to vet potential buyers against who should make the short list for consideration. There are a lot of different factors that go into listing your company for sale, but you want the peace of mind and the confidence that your business broker is handling these processes as effectively as possible.

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