Understanding the Appraisal Process
For many business their first appraisal may seem like a daunting experience. Taking a moment to read and better understand our process will help alleviate any concerns you may have. Should you have any further questions about how Jay, Cobb & Marley conduct appraisals, please feel free to contact us to speak directly to one of our highly experienced appraisers. We can be reached at (800) 304-4769 or through our contact form.
First and foremost, the lender wants to know what the inventory would sell for in a liquidation.
What kind of a value is being determined by the appraisal process?
Most often, JCM is asked to provide an ORDERLY LIQUIDATION VALUE. Simply put, this is a value that could be realized from the sale of the inventory over a reasonable period of time.
There have been some recent problems and the inventory is not representative of what it normally is. Will this influence the results of the appraisal?
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.
What can I do to mitigate a possible lower inventory value caused by my present circumstances?
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.
Is the liquidation value of the inventory a fixed amount or is it variable?
Traditionally the appraiser attempts to determine how much the inventory could be sold for during the liquidation.
Can the value of my inventory change over time?
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.
Will I have access to the report?
Generally, the borrower pays for the appraisal, but the appraisal is sent directly to the lender.
How will the lender use the appraisal?
The lender will use the appraisal to help evaluate the credit risk and help set the advance rate on the inventory portion of the loan he/she is providing to your Company.
Will the advance rate be exactly that same as the percentage of cost established by the appraisal?
Usually the advance rate on the final loan will be lower than the percentage of cost given for the appraised value . There are three common reasons why this might be the case.
First and foremost, JCM’s approach and the resulting report provides the lender with a better understanding of the business unit being appraised and the role of the inventory in generating revenue.
Are there any benefits to me, beyond securing the line of credit?
As part of the appraisal process, we look at the way that the company classifies its inventory. Traditionally inventory is broken down into Raw Material, Work-In-Process and Finished Goods.
What can I do to prepare for the appraisal?
JCM sends a “Wish List” to the borrower prior to the initial site visit so the management team can be prepared to discuss all of the things which will be covered during the appraisal process.
How long does the appraisal process take?
Overall, the appraisal takes as long as is necessary to do the job right.
Who should be involved from my Company?
In all cases, we need to talk to whomever has a high level understanding of the Company and the industry in which it functions.
What should I tell my people about what’s going on?
Generally, we are introduced as “Bank Auditors” or “Special Project Consultants”. We try to limit the “liquidation” word as it can sometimes cause anxiety.
I have inventory at multiple sites, does the appraiser need to see all of the inventory?
Our Company policy calls for the appraisers who are present during the initial site visit to see a minimum of 70% of the inventory being appraised.
Do I or my staff have any influence over the results of the valuation?
Yes. When we are given full, complete and usable information and feel that we have all of the facts, the value will be higher than when we feel there has not been full transparency.
Why is the lender asking me to have my inventory valued?
First and foremost, the lender wants to know what the inventory would sell for in a liquidation.
Additionally, the lender may ask for an inventory appraisal:
1. To determine an advance rate against your Company’s inventory.
2. To assess your Company’s systems and controls relative to the inventory.
3. To validate the current and future cash-flow generated by the sale of inventory.
4. To help assess the credit risk associated with the overall transaction.
What kind of a value is being determined by the appraisal process?
1. Most often, JCM is asked to provide an ORDERLY LIQUIDATION VALUE. Simply put, this is a value that could be realized from the sale of the inventory over a reasonable period of time. The value assumes the sale will be conducted by a qualified liquidator with the active participation and cooperation of the current owners and management. This is not an auction sale, it is a sale to the ordinary customer base, competitors and opportunistic buyers. The value we give the bank is net of liquidator’s fees and liquidation expenses. The inventory is valued as-is, where-is as of a specific date.
2. Sometimes were are asked for a DISTRESSED LIQUIDATION or FORCED LIQUIDATION VALUE. These values are oftentimes used interchangeably and the lender may ask for this value as a standalone value or in addition to the Orderly Liquidation Value. The time frame may be longer or shorter than the Orderly Liquidation model, depending on the unique circumstances associated with the project. In general, however, it is assumed that the ownership and top tier management are not a part of the liquidation because they are under the compulsion to liquidate their assets. In this scenario the Company’s customer lists, sales history, product certifications and other essential records may not be available to the liquidator. There is a higher reliance on the sale of the inventory to competitors and opportunistic buyers, which typically results in a lower return.
3. 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 it unsalable to retailers or merchandisers. We have found that combining an orderly liquidation with an auction at the end of the process, works well with such items as furniture, container plants, light fixtures, small electric appliances and other consumer oriented products.
3. A lender, business owner or someone purchasing the inventory may ask that we provide a FAIR MARKET, IN PLACE or ONGOING BUSINESS VALUE of the inventory. These values essentially validate the value of the inventory in the context of an ongoing business. The value may validate the book cost or the value may include anticipated margin and therefore the inventory at its sales value. As with all valuations of inventory, the appraiser looks closely at sales history, margin, costing, market comparisons and the condition of the inventory in order to assess the inventory’s viability within the context of an ongoing business.
There have been some recent problems and the inventory is not representative of what it normally is.
Will this influence the results of the appraisal?
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 therefore, 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 which 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.
What can I do to mitigate a possible lower inventory value caused by my present circumstances?
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 set of eyes and different approach to the inventory. Communicate positive changes relating to the inventory to your lender. Communication is essential because lenders give value to positive results.
Is the liquidation value of the inventory a fixed amount or is it variable?
Traditionally the appraiser attempts to determine how much the inventory could be sold for during the liquidation. This sales price is influenced by traditional margins, inventory turns, obsolescence, shelf life issues, market pressures and other variables addressed in the appraisal. It is important to remember that, most often, we are looking to the traditional market place to absorb more inventory than the historic normal sales.
The Gross Orderly Liquidation Value (GOLV), less the direct expenses associated with the liquidation effort is the Net Liquidation Value (NOLV). This value is normally less than the inventory’s Cost or Book Value. Also, again, this value is as of a specific point in time.
Because the liquidation value is dependent on an inventory that is fluid (inventory is added, converted and sold over time), the lending industry has decided that the liquidation value should be represented as a percentage of cost so it has relevance to future inventory monitoring.
Can the value of my inventory change over time?
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 is 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.
Will I have access to the report?
Generally, the borrower pays for the appraisal, but the appraisal is sent directly to the lender. This is done because JCM is typically engaged by the lender to appraiser your Company’s assets. With the permission of the lender, we will provide a copy of the appraisal to the borrower, answer any questions and/or issues subsequent to the completion of the appraisal report.
How will the lender use the appraisal?
The lender will use the appraisal to help evaluate the credit risk and help set the advance rate on the inventory portion of the loan he/she is providing to your Company. The lender will also use the data provided in the report to establish monitoring points and reporting conditions.
Will the advance rate be exactly that same as the percentage of cost established by the appraisal?
Usually the advance rate on the final loan will be lower than the percentage of cost given for the appraised value . There are three common reasons why this might be the case.
1) Most lenders will specify in their term sheet that they will advance only a percentage of the net liquidation value.
2) There is another industry anomaly that might effect the advance rate. It is rather common in the asset based lending community to limit the inventory advance so that it will never exceed 50% of the accounts receivable loan amount.
3) The last factor that could lock the advance is a “Loan Cap”. Simply put, this means that the loan limit might be below the combined maximum advance rates on the inventory components.
Does the appraisal provide the lender any information beyond the value?
First and foremost, JCM’s approach and the resulting report provides the lender with a better understanding of the business unit being appraised and the role of the inventory in generating revenue.
Our discussion points in the report include company history, management, systems, inventory controls, regulatory issues, manufacturing efficiencies, warehousing practices, overall inventory integrity, shelf life and housekeeping issues. In addition we look at inventory balances on a part by part basis relative to past, current and future usage and/or sales. As part of this analysis we look at the market in which the Company competes and discuss the Company’s place within that marketplace.
Because our appraisals address the Company’s systems, controls and reporting capabilities, the report will give the lender comfort relating to these areas and guidance on how to structure the loan and schedule future monitoring.
Are there any benefits to me, beyond securing the line of credit?
As part of the appraisal process, we look at the way that the company classifies its inventory. Traditionally inventory is broken down into Raw Material, Work-In-Process and Finished Goods. We have seen instances where the borrower has a lesser inventory advance rate because the borrower does not understand the impact of how he reports his inventory. For instance, the borrower may not move inventory out of WIP, when, by all essential standards, it is finished product that is saleable. By simply reclassifying the inventory the borrower might pick up additional advances against the inventory. JCM does not reclassify the Company’s inventory but instead tracks the inventory through the process by thoroughly understanding the Company’s business model and flow of inventory both in the system and throughout the facility.
More importantly, however, is the information and conclusions we provide in our report that are a result of our analysis. Inventory velocities on the SKU by SKU level, concentrations by part number and/or customers, inventory management, our interpretation of slow moving and obsolete inventory and other discussions pertaining to the industry and inventory issues in general, often give added insight to the Company’s management team.
What can I do to prepare for the appraisal?
JCM sends a “Wish List” to the borrower prior to the initial site visit so the management team can be prepared to discuss all of the things which will be covered during the appraisal process. Our “Wish List” is, by design, very comprehensive. We ask for inventory and financial data to be presented in a usable format so that we can perform our analysis. We are fairly flexible as to what type of files we can convert to our needs, but generally Excel and PDF files are the easiest to work with. It is helpful if this information is transmitted to us prior to the site visit so we can review the data and prepare additional questions in order to maximize our time on site.
We also ask questions that helps us personalize the assignment. We do not prepare a cookie cutter appraisal because each of the companies we appraise are unique. The Company’s management team, history, place within their industry, corporate culture and inventories are unique to them and should be considered within a going concern context.
Most important, however, is the allotment of time, effort and resources dedicated to us while we are onsite. In order to control expenses we attempt to limit our site visit to one day. We do this by sending two appraisers: a senior person (the primary interface) and a second appraiser (the project manager).
How long does the appraisal process take?
Overall, the appraisal takes as long as is necessary to do the job right. We have completed assignments in a week, but most assignments take several weeks because it takes time for the target company to prepare the necessary information and for us to analyze the information and
generate a meaningful report. The process is faster when we get usable information in a timely manner and are given access to the right people during our initial site visit.
Who should be involved from my Company?
In all cases, we need to talk to whomever has a high level understanding of the Company and the industry in which it functions. This person might be the President, CEO, COO, VP of Sales, CFO, Controller and/or the General Manager. One person might suffice, or several might be needed. That determination is made by the borrower upon receiving JCM’s “Wish List”.
During the visit, it is imperative that we are given access to employees who are knowledgeable about the inventory, the inventory software program as well as the internal systems and controls. In addition, we request that someone familiar with the sales and marketing aspect of the target company be available as well. If the Company manufactures, we should be provided with a full and in depth tour of the manufacturing facility. Sometimes the Owner, CEO and /or the CFO are able to give us the information we need. At other times we may need to interface with one or several of the following: the inventory specialist; the person doing purchasing; the warehouse manager; the manufacturing manager or VP of Manufacturing; and/or the Warehouse Manager.
What should I tell my people about what’s going on?
Generally, we are introduced as “Bank Auditors” or “Special Project Consultants”. We try to limit the “liquidation” word as it can sometimes cause anxiety. We have been dong this for a long time and we are very sensitive to your employee’s perceptions. We will follow your lead.
I have inventory at multiple sites, does the appraiser need to see all of the inventory?
Our Company policy calls for the appraisers who are present during the initial site visit to see a minimum of 70% of the inventory being appraised. This percentage is by business unit, so the actual inventory being viewed may exceed the 70% target. For example: if one business unit is distribution and the company also has retail locations, we would see 70% of the inventory in the warehouses and 70% of the inventory at the retail locations.
Site visits for Company Owned warehouses usually take no more than 2 hours and 3rd party warehouses take between 45 and 60 minutes. Typically, retail locations take about an hour per location. Remember, we do not perform a test count or physical inventory unless specifically requested to do so by the lender. Normally, however, this is an audit function and for us to perform a count would result in duplicity and additional fees.
Do I or my staff have any influence over the results of the valuation?
Yes. When we are given full, complete and usable information and feel that we have all of the facts, the value will be higher than when we feel there has not been full transparency. The more we know, the less we have to speculate. In the end, we are depending on people to provide us with good and reliable information and then to maintain the information in the same condition as it was when we inspected it.