Appraisals, Liquidations, Auctions, and Consulting

At this point in the appraisal process, the method and structure of cost will have been determined, and any required adjustments will have been made. If possible, such adjustments should be made at the individual line item level; at the very least, any global adjustment should be proportionately allocated. The next step is to sub-categorize the inventory into classes the appraiser expects will ultimately show varying degrees of recovery (return in dollars) on any subsequent sale. For a manufacturing inventory, these classes will be initially segregated into raw material, work-in-process, and finished goods.

Classifications:

1. Raw Material is “the items to be processed into saleable goods - specifically, the direct and indirect materials owned. The original source from which goods are manufactured.”

Raw material is typically the term used in a manufacturing operation to designate those commodity materials from which a final product is constructed. This can range from raw lumber in a furniture operation to magnesium used in the manufacture of titanium, the final product of which is also a raw material to another company. Emphasizing that one company’s raw material can be another company’s finished goods. In the titanium example, the actual raw material upon which titanium is based is extracted from sand imported from Australia and New Zealand. This extracted sand, once processed, is combined with other base metals such as magnesium, to form titanium sponge, which is considered a base commodity. This sponge is a finished good to the titanium processor, but is a raw material in such diverse products as bicycle frames and aircraft components.

Within the classification of raw material can be outside purchased parts such as printed labels, printed circuit boards, special hardware, and other proprietary items.

2. Work-in-Process is “the inventory of goods started but not completed during the period. Items transferred out of raw material being staged or used in the manufacturing or assembly process, up to and just prior to the completion of a total assembled and boxed unit”.

Work-in-process is inventory at an unfinished stage of completion within a manufacturing process. This, by definition, would exempt classification of these products as finished goods. However, it is likely there will be items contained within this area that are saleable. This is easily explained by the fact that almost anything, at one time or another has been inventory. Therefore, what is considered work-in-process to one company could contain parts considered a finished good to another. This would relate to purchased parts that are not designed for a specific use and are standard to the industry.

When valuing an inventory, there are instances where the appraiser must analyze the cost of completing the manufacturing process to determine if completing the work-in-process will justify the economic benefit. To do this, the following questions will need to be addressed by the appraiser:

1. At what stage is the work-in-process?

2. Are there enough raw materials to complete the work-in-process? If not, would it be worthwhile to replenish?

3. Is the facility owned or leased?

4. What personnel will completion of the work-in-process require?

5. What utilities and other cash expenses would be required to facilitate completion of the work-in-process?

6. What security measures would need to be undertaken during completion of the work-in-process? (Upon failure, some sort of security would be required to minimize vandalism and theft.)

7. What and how much insurance and/or operating permits would be required during completion of the work-in-process?

3. Finished Goods is “the inventory of completed products owned by a firm. The boxed and completely operable unit subject only to required consumer assembly”.

It is the goods in which the manufacturing process has been completed. Semi-Finished Goods are those items considered finished goods to another manufacturer or processor, but are still considered work-in-process to the subject company.

Manufacturers can classify inventory in many different ways and, therefore, the appraiser must know and interpret the mix of inventory within each classification to measure value.

4. Packaging Materials is “an aspect of inventory that tends to be proprietary in nature concerning name identification and designs specific to a product”.

Therefore, an appraisal performed under a “piecemeal” concept may exclude this classification of inventory, whereas it would be given value under an “in-use” concept. In any case, there are typically items within this class of most inventories that are not proprietary in nature, or subject to factors of depreciation. These areas include off-the-shelf packaging materials such as standard size boxes, containers, protective wrapping, and filler, which would be given consideration under any value concept.

5. Slow-Moving and/or Obsolete items can generally be defined as “any merchandise that cannot be disposed of by a company within a period of one year”.

This measurement is made by the appraiser through an analysis of the company's past sales history and its respective industry. However, inventory to a company is not always slow-moving due to limited market acceptance, demand, or some form of depreciation, but can be due to factors such as bad management, lack of operating capital, and over leveraging. Therefore, slow-moving inventory is, in effect, obsolete due to physical restrictions, and/or characteristics inherent in or external to the item.

Recovery of items within this classification is extremely volatile and nominal when compared with the whole. For these items, the recoverable value is affected to such an extent that, although these items are addressed in an appraisal, they could be excluded from the overall value depending on the purpose and function of the report.

6. Scrap can include “unusable materials that have some resale value in the scrap market, and are maintained on the books as such”.

Some metal and plastic operations produce residual materials such as plastic regrind, which is recognized as a commodity and routinely traded in the open market. Such scrap can have a high recovery when expressed as a percentage of cost. Major groups can be further segregated into smaller classifications and, in most cases, should be. For example, for the mattress manufacturer, the raw material subgroups might include wire, fabrics, foam, lumber, threading, preprinted labels, and any other classes that may be intuitively deduced as requiring unique classification.

The reason for going to this level of detail is that any user of the report could adjust values as the mix of inventory changes over time. Furthermore, this is the reason many clients prefer only expressions of value in percentage form rather than in currency.

Using this example, assume that an analysis and sampling have led to a conclusion of the following percentages of recovery as applied to cost. In addition, the following charts dramatize not only the potential impact of changes in mix, but also demonstrate why providing percentage expressions of value can be a useful monitoring tool. While swings in mix of this magnitude, as indicated by the two charts, are rare for an individual company, there have been many cases of a company experiencing financial difficulty and, therefore, a loss of value in those classes that can be easily sold as commodities. Even with a measurement as simplistic as that shown below, a potential lender, auditor, or any interested party may avert, or at least mitigate, the surprise element often produced by such developments. In this example, the inventory value improved, but brings up the point that the reverse could be true.

Inventory as of June 30
Product Class	Cost	% of Recovery	Value
Finished Mattresses’	$1,000,000	70%	$ 700,000
Work-in-Process @ Scrap	$ 500,000	10%	$ 50,000
Raw Foam (In Complete Rolls)	$ 100,000	50%	$ 50,000
Cut Foam	$1,250,000	5%	$ 62,500
Fabric In Rolls	$ 150,000	60%	$ 90,000
Packaging	$1,500,000	5%	$ 75,000
Total	$4,500,000	23%	$1,027,500

Inventory as of December 30
Product Class	Cost	% of Recovery	Value
Finished Mattresses’	$2,000,000	70%	$1,400,000
Work-In-Process @ Scrap	$ 100,000	10%	$ 10,000
Raw Foam (In Complete Rolls)	$1,100,000	50%	$ 550,000
Cut Foam	$ 300,000	5%	$ 15,000
Fabric In Rolls	$ 750,000	60%	$ 450,000
Packaging	$ 250,000	5%	$ 12,500
Total	$4,500,000	54%	$2,437,500