Wholesale and distribution business valuation

Whose value is it: yours or the supplier's?

A distributor that sells its own brands, or holds long agency rights, owns something durable. A distributor that sells another company's products on an agreement terminable on three months' notice owns much less, however good its sales figures look. The first question in any distribution valuation is how much of the gross profit comes from products the business controls.

Overseas manufacturers often appoint a local distributor to build a market, then review the arrangement once the market is worth having. Some appoint a second distributor, some set up their own subsidiary, some move to selling direct to the large customers. A buyer of a distribution business knows this history and will read the agreements line by line.

Where there is no written agreement at all, which is common, we look at the length and depth of the relationship, how much the supplier relies on the distributor, and what the supplier has done in other markets. We then reflect the risk in the earnings we treat as maintainable or in the capitalisation rate, and we say plainly in the report which one we have done.

Inventory turns, ageing and obsolete stock

Inventory is where distribution valuations most often go wrong. Accounting standards require stock to be carried at the lower of cost and net realisable value under AASB 102, so damaged or obsolete stock should already be written down. In practice, many private businesses carry stock at cost until it is finally thrown out, and the balance sheet overstates what the stock is worth.

We look at the stock ageing report, sales by line over the last twelve months, discontinued products, stock bought for one customer who has since left, and the results of the last stocktake. Inventory turns by product group show where cash is tied up. A distributor turning its core range six times a year and holding a long tail that has not moved in two years has two different stock problems, and a buyer will price both.

• Stock with no sales in twelve months is usually treated as worth less than cost, sometimes much less
• Stock held on consignment from a supplier belongs to the supplier until it is sold, so it is not counted in the distributor's stock or working capital
• Suppliers trading on retention of title terms may have a registered interest in stock until it is paid for, under the Personal Property Securities Act 2009 (Cth)
• Large write-downs in one year may be a clean-up rather than a recurring cost, and we normalise for that

How much working capital does the business need to trade?

A distributor has to fund the gap between paying its suppliers and collecting from its customers. Importers often pay before goods are shipped and sell on 30 to 60 day terms, so the cash cycle can run for months. Growth makes it worse: every extra dollar of sales needs more stock and more debtors before it produces any cash.

Business sales are usually priced on the basis that a normal level of working capital is left in the business at completion. We work out that level from monthly balances over at least a year, allowing for seasonal peaks such as stock built ahead of a busy quarter. If the business needs more working capital than its earnings suggest, that reduces what a buyer can pay for the earnings. See how working capital affects a valuation.

Debtor terms, deductions and who the customers are

Selling to large retailers, national trade chains or buying groups brings volume and pressure. Terms get longer, rebates and promotional allowances appear, and deductions taken from remittances without agreement can become a quiet drain on margin. We reconcile invoiced sales to cash received to see the real net price, and we look at debtor days, bad debts and any credit insurance.

Concentration matters in two directions. A distributor that depends on one supplier and sells most of that supplier's range to one customer can lose the business from either end. Our report sets out how much of the gross profit rests on each key supplier and each key customer. For the wider principles, see how customer concentration affects business value.

Margin squeeze, rebates, currency and landed cost

We analyse gross margin by supplier and by product line over several years, not just in total. Total margin can look stable while one key line is eroding and another is temporarily strong. Volume rebates from suppliers are often paid annually and booked at year end; they are part of the real margin, but only if the volume targets are likely to be met again.

For importers, landed cost includes the supplier price, currency, international freight, duty where it applies, and local handling. A distributor that buys in US dollars and sells in Australian dollars on fixed price lists carries currency risk between order and sale. We look at how the business has managed that in the past, whether it hedges, and how quickly it can reprice. A business that passed through a sharp fall in the dollar without losing margin has shown pricing power. One that did not has shown its limits.

Systems, warehouse and the people who hold the accounts

Electronic ordering links with major customers, a reliable stock system and accurate picking are worth more to a buyer than they appear in the accounts. They make the business harder to replace. So is a warehouse lease with enough term and space for the range. If the warehouse is run by a third-party logistics provider, we read that contract too. See our pages on 3PL and contract logistics valuations and warehouse and storage valuations.

People matter as much as systems. If the owner is the only person who speaks to the overseas suppliers, and two sales reps hold the main accounts without restraints, a buyer will discount for the risk that relationships walk out the door. A sales team with documented account plans, a second-in-charge who manages suppliers, and reasonable restraints in employment contracts all reduce that risk.

Earnings, assets and the right cross-check

Most established distributors are valued by capitalising maintainable earnings, after normalising the owner's pay, one-off stock write-downs and related-party rent, and on the basis that normal working capital stays in the business. We cross-check against the net value of the assets, because a distributor with weak earnings may still have saleable stock and debtors worth more than the goodwill. The general methods are explained in how we value industrial businesses.

The fee is fixed by turnover; the bands are on our pricing page, and you can request a quote online. If the valuation is for a sale, read our business sale valuation page. If shareholders are parting ways, see shareholder valuations.