Plus inventory or including inventory: the same business costs 180,000 more or less depending on one line of the letter of intent, and the multiple means nothing until it is stated.
Inventory is included in the purchase price only if the agreement says so, and many small business listings quote the price "plus inventory", paid separately at cost after a count at closing. On an illustrative 1,200,000 asking price, 3.00 times SDE, a count of 265,000 with 40,000 of slow stock priced at 10 per cent adds 229,000, so the buyer actually pays 1,429,000, or 3.57 times SDE. If the price had instead included a normal level of 180,000, the total would be 1,249,000.
Worked in full in Buying a Small Business by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The difference between the two readings is the normal inventory itself, 180,000 here, and it is often settled by the wording of the letter of intent rather than by anyone's view of value. Both readings are legitimate. What matters is that the multiple you compare against, from a broker, a comparable sale or a rule of thumb, was measured on the same basis as the deal in front of you.
| Input | Value |
|---|---|
| Verified SDE | 400,000 |
| Asking price, "plus inventory at cost" | 1,200,000 |
| Inventory shown in the listing | 250,000 |
| Inventory at cost per the closing count | 265,000 |
| Of which slow-moving, no sale in twelve months | 40,000 |
| Price agreed for slow-moving stock, share of cost | 10% |
| Cost of goods sold a year | 1,440,000 |
| Normal inventory turns a year | 8 |
| Financing: share of project lent, rate, term | 90%; 10.5%; 10 years |
1. Saleable stock = 265,000 − 40,000 = 225,000 at cost
2. Slow-moving stock = 40,000 × 10% = 4,000
3. Inventory paid = 225,000 + 4,000 = 229,000
4. Total paid = 1,200,000 + 229,000 = 1,429,000, or 3.57 times SDE
5. Normal inventory = 1,440,000 ÷ 8 turns = 180,000, or 45.6 days of cost of sales
6. Excess inventory = 229,000 − 180,000 = 49,000
Three things are being bought in step 4, and only one of them is earnings. The 1,200,000 buys the 400,000 of SDE. The 180,000 of normal inventory is working capital the business cannot trade without; it earns nothing on its own, but without it the SDE does not exist. The 49,000 of excess is a stock of goods that will turn into cash as it sells, roughly at cost, and is the only part of the inventory the buyer gets back.
| Structure | Total paid | Times SDE |
|---|---|---|
| Headline price, inventory ignored | 1,200,000 | 3.00x |
| Price includes 180,000 of normal inventory; excess paid at cost | 1,249,000 | 3.12x |
| Price plus all inventory at cost | 1,429,000 | 3.57x |
A buyer who benchmarks the 3.00 against comparable sales that included inventory is paying 3.57 on a like-for-like basis. A seller who agrees "including inventory" with no adjustment to a normal level, on a business carrying 67.2 days of stock, gives away the 49,000 above what the business needs as well as the 180,000 it does. Both errors come from the same place: the multiple has no unit until the treatment of inventory is stated.
Lenders usually finance inventory with the rest of the project. At 90 per cent, the 229,000 adds 206,100 to the loan and 22,900 to the buyer's cash; at 10.5 per cent over ten years that is 2,781 a month, 33,372 a year of extra debt service. The excess 49,000 releases cash only as it sells; the normal 180,000 never does while you own the business. Treat that extra debt service as a cost of the 1,200,000 deal, not as a separate item, when you test coverage the way it is done in the price a 1.25x DSCR supports.
| Count at cost | Slow-moving | Inventory paid | Plus inventory | x SDE | Normal included | x SDE |
|---|---|---|---|---|---|---|
| 200,000 | 20,000 | 182,000 | 1,382,000 | 3.46x | 1,202,000 | 3.00x |
| 265,000 | 40,000 | 229,000 | 1,429,000 | 3.57x | 1,249,000 | 3.12x |
| 320,000 | 90,000 | 239,000 | 1,439,000 | 3.60x | 1,259,000 | 3.15x |
A bigger count is not a bigger asset if the growth is in slow stock: the 320,000 count costs only 10,000 more than the 265,000 one once the 90,000 of slow lines is priced properly. The negotiation that matters is the classification of each line at the count, not the total.
The price, the working capital and the loan that sizes itself are worked for a real-sized deal in the free workbook for this case.
Usually at the seller's cost, from a physical count close to the closing date, with slow-moving or obsolete lines priced at a discount or excluded. On an illustrative count of 265,000, taking 40,000 of slow stock at 10 per cent gives 229,000; paying full cost for it would overpay by 36,000.
That the asking price excludes stock, which is paid on top at cost after a count. A 1,200,000 asking price with 229,000 of inventory is a 1,429,000 purchase. Against 400,000 of SDE that is 3.57 times, not 3.00, which matters when the comparables you rely on included inventory in their price.
Cost of goods sold divided by the normal number of turns a year. A business with 1,440,000 of annual cost of sales turning stock 8 times needs about 180,000, roughly 45.6 days. Inventory bought for 229,000 then carries 49,000 of excess that will convert back to cash only as it sells.
This article is one calculation from Buying a Small Business. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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