Below is a list of useful definitions…
Experience, timing and cost are all important. Please go to the web page that we have devoted to this question for a more detailed answer.
Sometimes. The management of company being appraised often tries to find an appraisal firm that will give them a high orderly liquidation value. Credit officers attempt to find appraisal firms to give values based on the circumstances of the company at the time of the appraisal. For that reason it is sometimes difficult to convince the lender to use a firm that is not on its approved list. If the appraiser that the company wants to use is on another major lender’s list, it is often possible and that they will make an exception or will add the appraisal company to their list on a one time basis.
Within reason, yes. Most lenders have a list of approved appraisers. Sometimes the lender will provide one name based on his experience with the appraiser or the firm for which he works and his belief that the appraiser is the most qualified for the assignment. Sometimes the lender will provide several names and let the management of the company decide which firm they would like to use. There are times, however, when the lender mandates the appraiser.
No, all appraisal firms have a limited number of senior people and they are not necessarily located in every area of the country. Most firms draw from a local pool when possible, but will send the most experienced person available, based on the industry in which the company operates. In the end, is it more important to save a couple of hundred dollars or to have an advance rate that is based on logical conclusions from an experienced appraiser.
No inventory appraiser knows everything about everything. Good appraisers are very knowledgeable about inventory in general, and somewhat knowledgeable about specific inventory. Management should capitalize on this fact by being cooperative, open and providing total disclosure while the appraiser is on-site so that the appraiser has the facts on which to base his conclusions. In reality, appraisals tend to be higher when the appraiser can quantify the information that is presented to him. If the appraiser must guess, then he will probably guess low.
Inventory appraisal firms and the appraisers who they employ provide an OPINION OF VALUE. This value is based on sound appraisal practices, experience, and the input provided by the management of the company being appraised and the analysis of the information provided by the company. No appraiser should be married to their value and every appraiser should be willing to change their value as circumstances change or if new information is presented. At the same time, every qualified appraiser must stand behind their value when, in his opinion, that value is valid and represents the facts as he sees them.
To be fair, accurate and reasonable, the appraiser should talk to the management of the company about any findings or conclusions that could potentially affect the company negatively, however the appraiser has a fiduciary responsibility to fairly represent the facts, as he sees them, to the lender. This means that both good and bad information should be transmitted through the inventory appraisal and presented in a balanced way. Experienced inventory appraisers understand that there are often significant consequences as a result of the conclusions reached in the appraisal and make every attempt to be fair.
Are there any direct benefits to the company being appraised as a result of the inventory appraisal?
Yes, as we pointed out earlier, a good appraisal will show both positive and negative factors associated with the inventory and the way the inventory is handled. On top of that, an appraisal should help to validate your balance sheet and your profit and loss statement. Inventory is the source of the cash flow and is directly related to the quality of the accounts receivable. Referring to the inventory appraisal can validate cash flow projections, on which you and your lender are relying. This is because most inventory appraisals will reference salable versus non-salable inventory and cash flow projections should only use the salable segment of the inventory in the projections. Lenders do not like surprises.
It’s one of those ironies in life that the company being appraised gets to pay for the appraisal, but the appraiser works for the lender. In most instances the report is sent directly to the lender and the company being appraised must ask the lender for a copy of the appraisal or direct the appraisal firm to release a copy.
The borrower normally pays for the appraisal. For a new business transaction, the cost associated with the appraisal may come out of a deposit given to the lender or it may come from the potential borrower directly. If the payment for the appraisal is to be paid out of a deposit the payment is made at the end of the process: if the borrower is paying for the appraisal on a direct basis, the payment is made up front. For a company that is currently in the lender’s portfolio, appraisal fees are normally charged directly to the loan.
Though your options are limited, you definitely do have some options. First of all, ask your lender to use an advance rate that relies on a valuation whereby the important elements of the inventory are valued separately. This means that your inventory value changes in proportion to the improvements that you make on the various elements. If, for instance, you have three distinct product lines in your finished goods inventory and two of the product lines have a lesser value than the third, the overall orderly liquidation value will improve as you are able to improve your inventory mix. Remember, with impaired working capital your best inventory will have little or no depth and the slower moving elements will influence the overall value.
Often times the appraisal will point out factors relating to the inventory, which the company has not considered in the past. This is as a result of a fresh and different approach to the inventory. Look seriously at conclusions presented in the appraisal and make changes where appropriate and possible. Communicate positive changes relating to the inventory to your lender. Communication is essential because lenders give value to positive results.
Absolutely! Over time, when the company is properly funded and has a better working capital position, the company will have more depth to their inventory and, by default, a higher liquidation value. If the appraiser has an expectation of change as cash flow increases that are based on the company having good management, adequate systems and controls and a viable product, this should be pointed out in the body of the appraisal.
This liquidation value will be used to determine the advance rate against future inventory advances. Sometimes the lender will use the aggregate percentage of the inventory’s cost that the appraiser used to represent the NOLV to determine future advance rates and sometimes, if the appraisal was valued in meaningful segments, the lender will use the appraised value of the segments to determine the advance rate.
Yes, current circumstances will affect the value. This is especially true of companies who have had recent cash flow problems. An appraisal is a snapshot in time and the circumstances in evidence at the time of the appraisal will heavily influence the appraised value. When the company has cash flow problems, management must allocate every dollar that comes in and inventory purchases and inventory balances are severely affected. For a distributor, only that inventory which has proven to have high customer demand is purchased and, as soon as it hits the receiving dock, it is shipped. Similarly, a manufacturer only purchases inventory that supports its fast moving products and often times the finished goods inventory only reflects stock that is being accumulated for full shipments. As a consequence, the less valuable, slow moving and/or obsolete inventory represents a higher percentage of the total inventory on hand which distorts obsolete and slow moving inventory as a percentage of the total inventory.
Unfortunately, each inventory is unique unto itself. In order to be fair, a site visit is necessary where the company’s management is interviewed, information is collected and trained and qualified appraisers inspect the inventory. From this activity a value that is specific to the circumstances that exist on the day of the appraisal is prepared and submitted to the lender.
Your accountant has a different orientation than an inventory appraiser. He is primarily concerned with looking at inventory issues such as costing, count and obsolescence from an accounting perspective. He wants to make sure that the inventory was properly accounted for in order to validate the company’s financial statements and therefore his financial condition. Because the inventory is there does not mean that it has value. An appraiser looks at these same issues, but from the standpoint of valuing the inventory. If the count is wrong, the costing is inconsistent with reality and/or there is a significant segment of the inventory that is slow moving or obsolete then the liquidation value of the inventory will be adversely affected. Likewise, well-managed inventory that is adjusted for cost or market and which is produced or purchased with some rhyme or reason will have more value during liquidation.
The value is normally presented to the lender as a percentage of the inventory’s cost. This value is normally represented as a NET ORDERLY LIQUIDATION VALUE (NOLV) that is a number that takes into account the gross return that can be expected from the sale of the inventory and the costs associated with the liquidation process. These expenses include: scaled down facility expenses; the salaries of any support staff which are retained by the liquidator; shipping expense (if applicable); selling expenses and liquidators fees.
An orderly liquidation value assumes that a reasonable amount of time will be allowed for the liquidation, usually between 60 and 180 days. It further assumes that, at least during the preliminary stages of the liquidation, the normal customer base will purchase inventory that is supported by open purchase orders or because they are in the habit of purchasing inventory from the company at or near full margin. As inventory immediate demand is met, the inventory is depleted and mix is affected the inventory is less likely to be sold at its full market potential. This type of liquidation anticipates that the company’s infrastructure will remain intact and that the liquidator will be helped in his efforts by the company’s owner(s) (if it is closely held), various members of the upper and middle management team, applicable sales staff, and staff familiar with the company’s logistics and traffic, warehousing and plant security.
A distressed liquidation value assumes that some extended time frame will be allowed for the liquidation and that: there is a potential breakdown of the infrastructure and the liquidator will have very limited or no support from current company employees; there are conflicts between current management, owners and the lender; there is a significant interruption between the end of normal business operations and the beginning of the liquidation; there is a potential inherent problem with the inventory, either in its quality or marketability or existence; or the computer has been flushed and there is no inventory listing and/or customer list to help the liquidator with the liquidation. In general, the cost of the liquidation goes up and the return goes down.
An auction value is the least common request from the lender because, in the vast majority of inventory liquidations, an auction is the least productive method to liquidate. Auctions are sometimes, however, held in conjunction with orderly liquidations where the majority of the inventory has been sold through normal channels but where the inventory has an appeal to the general public. In these circumstances, the general public might be invited to buy the inventory that is not attractive to commercial buyers because size run’s, quantities or other inhibiting factors make them unsalable to retailers or merchandisers. We have found that combining an orderly liquidation with an auction works well with such items as furniture, container plants, light fixtures, small electric appliances and other consumer oriented products.
Most likely, the lender is asking for an orderly liquidation value. Some lenders will also ask for a distressed value or an auction value.
First, and foremost, the lender is attempting to ascertain the credit risk associated with lending against the inventory. Basically, he wants to know; if the inventory would have any value during liquidation; how much it would cost to liquidate the inventory; how long the liquidation would take; and what, if any, his potential net return might be.