Is stock included in a business valuation or added on top?

The short answer, explained

When a valuer works out what a business is worth from its earnings, those earnings depend on having stock on the shelves. The valuation therefore assumes the business comes with a normal level of saleable stock, in the same way it assumes the plant and equipment come with it. Stock is inside the number, not on top of it.

A listing or a contract may instead say "$600,000 plus stock at value" (sometimes written "plus SAV"). That price covers the goodwill, plant and fit-out only. The stock is counted at or near completion and paid for separately, on top of the headline price.

Neither approach is wrong. The problem arises when a valuation that includes stock is compared with a sale price that excludes it, or when stock is added to a valuation that already included it.

What a valuer looks at

The normal level of stock. A valuer looks at stock levels across the year, not on one date, and compares them with sales. The aim is to find the amount the business needs to trade at the earnings level being valued. A seasonal retailer may carry far more stock before its peak than after it.

Quality, not just quantity. Stock is only worth something if it can be sold. Lines that are damaged, expired, out of fashion or no longer stocked by suppliers may be worth far less than they cost. For financial reports, AASB 102 measures inventories at the lower of cost and net realisable value. For tax, the ATO allows stock on hand to be valued at cost, market selling value or replacement value, and Taxation Ruling TR 93/23 says obsolete stock that remains on hand should generally be valued at its scrap value. These rules show that stock which cannot be sold in the normal course is not worth its cost, but neither rule fixes the price of stock in a sale. The contract does that.

Excess stock. Stock well above the normal level is extra working capital. In a valuation that assumed a normal level, saleable excess stock can be added. A shortfall below the normal level is deducted, because the buyer would have to spend money restocking. Our guide to how cash and debt affect a valuation covers how these items fit into the wider move from business value to share value.

How "plus stock at value" works at completion

In a sale on a plus stock basis, the contract usually deals with:

• When and how stock is counted, for example a stocktake on or just before the completion date, attended by both sides or done by an independent stocktaker.
• The basis of value, for example cost price excluding damaged or unsaleable items. The contract wording matters: "cost", "landed cost", "lower of cost and net realisable value" and "value" can produce different totals.
• Rules for slow and obsolete stock, such as excluding stock older than a set age, or valuing it at an agreed discount or at nil.
• Caps or ranges, where the parties agree a minimum and maximum stock figure so that neither side is surprised.

business.gov.au notes that a sale contract should set out the assets included in the sale, and stock is one of the items it lists. If a contract is silent on how stock is valued, that is a gap for the parties' lawyer to close before signing.

Worked example: comparing a valuation with a plus stock price

This example is hypothetical. The figures are round numbers chosen to show the steps.

A valuation from earnings puts the business at $750,000, including a normal level of saleable stock of $150,000. That means the business without its stock is valued at $750,000 less $150,000, or $600,000.

The parties agree a sale at $600,000 plus stock at value. At completion the stocktake finds:

Reconciling to the valuation: the stock delivered at agreed value is $170,000, which is $20,000 more than the $150,000 normal level. $750,000 plus $20,000 is $770,000, so the two approaches agree once they are on the same basis.

The double-counting trap: if the buyer had treated the $750,000 valuation as excluding stock and offered $750,000 plus $170,000, the price would be $920,000. That is $150,000 more than $770,000, which is exactly the normal stock counted twice.

Limitations

• In a share sale the stock stays in the company, and a sale contract may adjust the price for working capital at completion rather than through a separate stocktake payment. See business, shares or units.
• Some businesses, such as a service firm, carry little stock but hold work in progress, which raises similar questions under a different label.
• The tax and accounting rules cited here govern tax returns and financial reports. They do not decide the price of stock in a contract.
• This page does not cover the GST or income tax treatment of a sale. Ask your accountant before signing.

Next steps

• Ask your accountant for month-end stock figures for the last two years so the normal level can be seen.
• Identify slow, damaged and discontinued lines before any stocktake, rather than arguing about them on the day.
• When comparing a listing price with a valuation, write both on the same basis: either both including stock, or both excluding it.
• Have your lawyer check the stock clauses in the contract: count date, basis of value and treatment of obsolete stock.

General educational information, not financial, tax or legal advice. Worked examples are hypothetical and do not value a real business. A valuation depends on its purpose, the evidence and the agreed scope.