Inventory Appraisals for Bankruptcy

Inventory Appraisals for Bankruptcy

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There are many reasons why inventory needs to be appraised, but two are prevalent. One is for use in obtaining a DIP loan using the revolver loan vehicle. The second is for those states having ad valorem tax applied to inventory, where the apraisal is important to determine the true value within the market. There is no question that one of the most attractive asset-based loans for lenders is the inventory revolver, second only to receivables. As banks and other lenders become more aware of the various factors that affect value, appraisers are being asked to become more sophisticated in their analysis. This also needs to be understood by those representing debtors so that good decisions are made in using that asset to assist in the rehabilitation.

Not too long ago, lenders would make certain assumptions, then use the borrowers' cost and fund an acceptable percentage as might be prescribed by the internal limits or guidelines of that financial institution. Since that time, many new technologies have been developed that allow a better analysis so that higher or more competitive loans could be made against these types of assets. In some cases, these analyses have proven that the advance rates were too aggressive. The biggest change, after the computer and larger hard drives with faster operating systems, was the ability to load the inventory files from the prospective client to the appraisers' computers so that all of the data could be analyzed.

From this beginning, there has been added special programming using large data storage computers with very fast operating systems to further enhance the inventory appraisal process. Other areas could be looked at as well, such as cost comparatives for like items, cost trends, new and older items, categorization, exclusions (items not marketable that should be excluded for lending) and many other areas. Some appraisers thought that this was all that was necessary and therefore would simply do this exercise and then apply a percentage no differently than the past lending practices. Many debtors do not look at their inventory in the same way as required by lenders. Some companies do not have the resources to have a full and complete inventory computer run, though there are ways to handle this. These are taught in an appraisal course offered by the American Society of Appraisers (ASA). The course is designed in order to teach about the unique characteristics of some inventories and the manner in which they may be kept.

An inventory appraisal is not an audit, but there should be some confidence in the reasonable accuracy of the on-site inspection.

There is nothing better than being involved in the education and application from a lender's point of view. It is extremely difficult to recognize the situations and/or forecast events that could put a value in jeopardy, although some of these may be unavoidable. A few of the problems arise from economic or functional obsolescence. An economic occurrence is the recent saturation of Boeing 727 aircraft parts that has driven the re-market price for these assets to an all-time low. When this happens, those in that market may not want the parts at anything other than a giveaway price, and the bidders are few. The depreciable effect is not simply linear to the market but exponentially lower, due to all of the other effects including an unknown length but anticipated holding period. "Stage Three" (government imposed noise restriction for engines) in aircraft is another anticipated effect and can now or later affect aircraft and their associated parts. Computers and the equipment that becomes outdated is an example of functional obsolescence.

Selecting the Appraiser

The very first thing to look at is the appraiser or his/her company to see how many inventories or workouts they have personally conducted. The appraiser should have some expertise on the subject category of the inventory. This may include being involved in the industry, doing work associated with the subject and so forth. For example, how can one appraise an aircraft if never before associated with the subject? This area is very specialized, and most of these individuals were formerly or currently pilots as well members of the appraisal profession. One can hire an outside contractor that knows the subject, but to do such a study without that expertise on that type of category would be improper.


It is not good enough to simply use a computer and come to some conclusion other than to show the work that was done in order to apply the additional required analysis. The new technology is good and will assist an appraiser to make a more logical and accurate decision. However, there is much more that needs to go into the valuation so that the indication represents a good analysis of what may be forecastable. This means that the onsite work and questionnaire should be representative of the current and future market as may be forecast.

On-site sampling and testing should be conducted regardless of any recent audit. An inventory appraisal is not an audit, but there should be some confidence in the reasonable accuracy of the on-site inspection. A recent aircraft inventory appraisal was conducted for a major airline, and the representation of a portion of the inventory was at a multimillion dollar level. The on-site inspection found huge errors in the unit-of-measure areas. As an example, 9,000 rivets may have been shown at a cost of $13.23 each, whereas the unit of measure was by the pound and there were four pounds. There were cotton swabs at a cost of $5 or $6 each and tongue depressors listed in this data at some ridiculous amount. The difference on the unit of measure and miscellaneous items was more than $700,000; a desktop may not have caught this, although the unit of measure cost, if individually observed in the data, may have been suspect.

With aircraft parts, there are many factors, such as condition indicators, that must be established with the items, and only an on-site observation would allow that to be confirmed. Condition of any inventory, whether it be manufacturer or distributor or retail, requires the on-site inspection, so what good are updates if no inspection is required? The update can show differences in mix and turns unless there is fraud involved. Since the on-site work is not an audit, there may be undetected fraud, but certainly there is more chance of discovery if there are more inspections. Lenders are developing certain guidelines and can require audits for confirmation of those assets and the related mix in intervals that would be recommended due to the nature of the subject. This should be expected if one is going to use the inventory revolver loan for a debtor that is going after that type of financing. The lender is going to cross-check invoices to confirm that the cost prices are appropriate.

Another new development is referred to as the "exit strategy." Nearly all lenders are now asking for this to be included in the appraisal report as a best estimate for how to liquidate in the event they have to sell the inventory. The appraisers who are selling as well as appraising have some unique perspectives on this subject and could be helpful in assisting the debtor in looking at the potential for obtaining the revolver loan. In addition, there are times where the reorganization plan may have a liquidation aspect where the liquidator/ appraiser could be helpful. There is always the criticism that can be made about a conflict of interest in being in both positions of selling and appraising. Although there is some merit in this point, there is no way to be qualified in the exit strategy without having some expertise in the selling. There is always the possibility of having the appraiser as the advisor and another appraiser is used as an overseer of the sale. However, this may not be necessary if the use of the expert is accomplished in the proper way. It is always possible that the initiation of a loan does not mean that there will be a liquidation effort in the future. Remember, at that point, the idea is all about the rehabilitation of the company.


Appraisals are appropriate for revolver loans and, if conducted by those in the know, can be very valuable guidelines. That is not the end-all, as anyone who wishes to create bad inventory status reports can do so. One must be monitoring these inventories, and most inventory lenders recommend that an inventory valuation should be obtained from an appraiser that allows a proper cross-check for inventory changes. Most appraisers will be able to give a value-added feature within the original study. They should be able to give appropriate advice as to what could be expected based on the type and mix of inventory. There are still changes going on and new innovations by the appraisers that originated the use of these type of studies.

Journal Date: 
Thursday, May 1, 2003