Key Takeaways

  • When deciding how to value inventory for a sale, pick and disclose a consistent costing method (FIFO, LIFO, weighted-average, or specific identification) and apply the “lower of cost or net realizable value/market” rule to avoid overstating assets.   
  • Include all allowable costs in inventory (materials, direct labor, allocated overhead, inbound freight, handling, duties) and exclude non-allowable costs; this prevents disputes at closing.
  • Adjust the quantity and price for obsolete, damaged, slow-moving, or seasonal items—buyers will mark these down to NRV.  
  • Verify counts with a physical inventory and reconcile your system (periodic vs. perpetual), while testing cut-off, goods-in-transit, shrinkage, consignment, and cycle-count exceptions.   
  • LIFO can match recent costs to current revenues but is not permitted in many countries; expect buyer diligence on method consistency and tax effects.

How to value inventory when selling a business is a valid concern since there is more than one way to valuate inventory. For example, inventory can be valued according to the wholesale price or the retail price. Which you use will depend on the circumstance. There may also be questions over how much inventory to include in the sale price of the business. The buyer may want to consider inventory separately from the business.

There is no one correct way to approach this. Each situation is unique, so it usually comes down to the seller and buyer reaching an agreement.

Do You Include Inventory in the Business Valuation?

On the one hand, it makes sense to include inventory as part of a business valuation. You need inventory to keep the business running profitably after you buy it. That inventory is what gives value to the business. The seller, however, might not want the inventory considered as part of the business valuation. The seller bought that inventory separately and might need it to pay off debt.

Retail businesses usually have their inventory priced separately. But there are important considerations:

  • Is the inventory of salable quality?
  • How much inventory is necessary to run the business after buying it?
  • Must the buyer purchase obsolete inventory, and if so, at what price? The buyer will be less likely to buy inventory that will not turn a profit in a reasonable amount of time.

The nature of the business can affect the value of the inventory. Electronics stores constantly need to keep up with changing technology. Clothing stores change stock with the seasons and fashions. In both these cases, old stock is of little value because it is hard to sell. Some businesses have inventory that defies technological innovation and fashions. Their stock will hold its value for years.

For the buyer, the decision to include or not include inventory in the business valuation must keep in mind a single truth: the amount you pay for the business must allow you to service debts, give yourself a salary, and keep growing the business.

Choose Costing Method & Apply the Market Rule

When a buyer asks how to value inventory inside the overall purchase price, they’ll expect you to (1) state the costing method and (2) apply the market constraint so ending inventory isn’t overstated. Common methods are FIFO, LIFO, weighted-average cost, and specific identification—each changes reported COGS and margins. FIFO often mirrors actual flows but can increase reported income (and taxes) in rising-price environments; LIFO better matches current costs to current sales yet isn’t allowed under many countries’ accounting rules. Weighted-average simplifies tracking; specific ID fits high-value or unique items.  

Beyond method, buyers typically require inventory to be measured at cost and constrained by lower of cost or market/NRV so that market declines don’t inflate value.  

Finally, be explicit about what costs are included in “cost”: e.g., direct labor and materials, allocated factory overhead, freight-in, handling, and import duties. Agreeing on these inputs up front reduces post-close adjustments.

How Much Inventory?

Before closing the sale, the buyer and the seller need to come to an agreement on how much inventory to include.

If there is more than enough inventory to keep the business running, the buyer can:

  • Sell the inventory at discount and offer the seller a percentage of the wholesale price
  • Pay the seller for the inventory as it sells
  • Have the seller finance the inventory on terms commensurate with expected sales
  • Allow the seller to keep all excess inventory

If inventory is a stumbling block to the sale, consider the quality and content of the inventory.

  • What has the inventory turnover ratio been like over the past few years? How does it compare to the rest of the industry?
  • Has the inventory been appropriately balanced and funded according to sales and inventory classifications?
  • Does the inventory contain items that are seasonal, damaged, old, or obsolete? Consider removing them.
  • Does the current inventory reflect the direction you intend to take the business? If not, do not include it.

Quality Adjustments: Obsolete, Seasonal, Damaged & Slow-Moving

Quantity alone doesn’t answer how to value inventory—quality drives the pricing haircut. As part of diligence, identify items that can’t sell at full price because of damage, obsolescence, or shifts in demand, and mark them down to NRV. Expect buyers to push for discounts or exclusions on these items.  

Practical steps buyers use (and sellers can pre-empt):

  • Aging & turnover review. Flag SKUs with long days-on-hand or weak turnover and support any proposed markdown with sales history.
  • Seasonality scan. Separate out-of-season goods that require clearance pricing.
  • Condition grading. Carve out damaged/returns for separate pricing or disposal.
  • Method consistency. Show that FIFO/LIFO/average is applied consistently across SKUs and periods so comparisons are meaningful.
  • Policy alignment. Document your write-down policy to NRV and how it flows into COGS so the buyer can mirror it post-close. 

For planning and negotiations, note that businesses select a valuation approach that aligns with accounting practices and reflects financial position, and accurate valuation supports credible financial forecasts and working-capital planning—topics buyers will probe. 

Counting Inventory

The buyer's accountant will want an exact count of the inventory. Both the buyer and seller will also need a physical inventory count to determine the fair market value of the inventory. This should be done prior to closing.

There is no substitute for physically counting the inventory. Stock control software can be useful and give accurate results. However, it cannot account for:

  • Data entry errors
  • Software problems
  • Shoplifting

This is how a computer may report something as being in stock when it is not. Only a physical count can verify the computer's information.

The buyer and the seller should both perform their own physical count a few weeks prior to the close of escrow. This will give them both a sense of the quality of the inventory and help them determine what to consider salable merchandise.

They should then hire an independent inventory service company to conduct the final count. This is an additional expense, but it will provide a detailed and precise cost value of the inventory.

Due Diligence Checklist: Systems, Cut-Off, Transit & Consignment

A physical count before closing remains essential, but buyers also reconcile counts to your system and test edge cases:

  • System method: Identify whether you run periodic (count at period-end) or perpetual (continuous) and reconcile variances.
  • Cut-off testing: Capture receipts/shipments that straddle the count date so items aren’t double-counted or missed.
  • Goods in transit: Clarify inclusion rules (e.g., shipments not yet received) and document which items are counted.
  • Consigned stock: Exclude supplier-owned consignment inventory from valuation unless purchased at close; tag clearly.
  • Shrinkage & cycle counts: Use cycle-count results and audit findings to adjust for theft, damage, or record errors. 

These procedures help the parties agree on a fair market value for inventory and reduce purchase-price true-ups later.

Frequently Asked Questions

  1. Which valuation method should I use for a sale?
    Pick the method you’ve used consistently (FIFO, LIFO, weighted-average, or specific ID) and disclose it; each affects COGS, taxes, and the price discussion.  
  2. Do buyers value inventory at cost or selling price?
    Generally at cost, constrained by lower of cost or market/NRV; items that won’t sell at full price are written down.  
  3. What costs are included in inventory value?
    Allowable costs commonly include materials, direct labor, factory overhead, freight-in, handling, and import duties.
  4. How should I handle obsolete or seasonal inventory in a sale?
    Identify, segregate, and mark down to NRV based on sales outlook and condition; expect buyers to discount or exclude these items.
  5. What controls do buyers check during the count?
    They reconcile your physical count with the system (periodic or perpetual), test cut-off and goods-in-transit, and reflect cycle-count/surprise-audit results. 

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