What is net orderly liquidation value (NOLV) for inventory?

What NOLV measures

An inventory appraisal answers one question for a lender: if this business stopped operating and we had to turn its stock into cash, how much would we end up with? Net orderly liquidation value is the answer under a specific set of assumptions. The sale is orderly: conducted over a reasonable period, typically a matter of months rather than days, with the goods marketed to the buyers most likely to pay for them. The inventory is sold as is, where is: no further manufacturing, no new marketing, no warranty. And the figure is net: the costs of conducting the sale come off the top.

Three neighboring values show up in the same report and are easy to confuse. Gross orderly liquidation value is the sale proceeds before costs. Forced liquidation value assumes a much faster sale, often a single auction, and comes in lower. Cost is what the business paid or spent to make the goods, which is the number on the balance sheet and in the borrowing base certificate. NOLV is the one lenders lend against, because it matches the way a secured lender actually recovers: through a managed wind-down, paying a liquidator, keeping the lights on while the goods sell.

The same concept applies to machinery, where it is usually called orderly liquidation value; orderly liquidation value vs fair market value covers that side. This page is about inventory.

How an appraiser arrives at it

An inventory appraiser works bottom up. The appraisal usually starts with a site visit and the company's perpetual inventory records, then values the stock category by category, sometimes item by item for the largest lines.

• Gross recovery by category. For each category the appraiser estimates what a liquidation buyer would pay, drawing on the company's own sales history and margins, recent liquidations of similar goods, and who the buyers would be: the company's existing customers, competitors, jobbers, closeout buyers or scrap dealers.
• Sell-through and timing. The appraiser estimates how much of each category would sell during the liquidation period and at what discount. Fast-moving stock sells close to normal wholesale; slow-moving stock sells late and cheap, or not at all.
• Work in process and raw materials. Work in process is often valued at scrap or near nothing, because finishing it would require running the business. Commodity raw materials hold value; specialized components may not.
• Liquidation costs. The appraiser then deducts what the sale would cost to run: the liquidator's fee, rent and utilities for the sale period, payroll for the staff who pick, pack and ship, advertising, freight and insurance.
• Monthly rates. For seasonal businesses the report often gives a different recovery rate for each month, because the same inventory is worth more before its selling season than after it.

The result is expressed as a recovery rate against cost, by category. The lender then applies that rate to the cost the business reports each month on its borrowing base certificate, so the appraisal does not need to be redone every time inventory levels change.

A worked example

A distributor carries inventory at a cost of 1,000: 600 of finished goods, 300 of raw materials and 100 of work in process. The appraiser's estimate runs like this.

Inventory that cost 1,000 supports an advance of about 468, a little under half of cost. That is why the rule of thumb for inventory, roughly half of cost, and the more precise version, up to 85% of NOLV, often land in the same place. Where they differ, the NOLV version governs, and it can differ a lot: a business with mostly finished, branded, fast-moving goods may appraise well above half of cost, and one with custom components and work in process well below it.

Inventory on the balance sheet at 1,000 is not 1,000 of collateral. It is whatever the appraisal says a wind-down would net.

Why lenders advance against NOLV, not cost

Cost tells a lender what the business paid. It does not tell the lender what anyone else would pay, and in a default the lender is selling to someone else, on the lender's timetable rather than the market's, without the business's sales team, and with the costs of the sale coming out of its own recovery. Several things drive the gap between cost and NOLV:

• Liquidation buyers pay less than customers. The buyers in a wind-down are closeout buyers and competitors buying at a discount, not the customers who pay full price in the ordinary course.
• Some stock is only worth something inside the business. Components built to the company's own designs, packaging printed with its brand and partly finished goods are worth far more to the going concern than to anyone else.
• Selling costs money. Someone has to run the sale, and the lender pays for it out of the proceeds.
• Accounting cost varies. Two companies holding identical goods can carry them at different costs depending on their costing method and how much overhead they capitalize. The appraisal cuts through that.
• Stock ages. Cost stays the same on the books while a product's market value falls. The appraisal and the eligibility rules catch it; cost does not.

Advancing a share of NOLV rather than all of it leaves a cushion for the appraisal being wrong, for inventory shrinking between appraisals and for the lender's own legal and collection costs. That cushion is what lets an inventory lender lend at all against an asset this hard to value. How lenders advance against inventory covers the eligibility rules and sublimits that sit alongside the advance rate.

What moves NOLV up or down

Location matters because a lender has to be able to get to the goods and sell them from where they sit. Inventory in leased premises usually needs a landlord waiver, or the lender holds back an availability reserve for the rent a landlord could claim. Goods at a third-party warehouse or processor need a similar access agreement.

NOLV over the life of the line

The appraisal is done before closing and then refreshed, commonly once a year and more often when inventory is a large part of availability or results have weakened. Between appraisals the recovery rates stay fixed while the reported cost moves, and the field exam checks that the cost being reported is real: that the perpetual records agree with the ledger, that counts support them and that slow-moving stock is being flagged.

A new appraisal can move availability either way. If product mix has shifted toward faster-moving finished goods, recovery rates rise. If the business has built up stock that is not selling, rates fall, and the borrowing base can drop on the day the new report is adopted, with no change in the cost on the books. Businesses with inventory-heavy lines watch for that and keep enough excess availability to absorb it.

NOLV also explains a structural limit. Because inventory recovers less than receivables and costs more to liquidate, most loan agreements cap how much of the borrowing base inventory can supply. A business whose working capital is mostly inventory will find its line sized by that cap as much as by the appraisal. Asset-based vs cash-flow lines explains when a cash-flow line, which does not depend on an appraisal, fits better.

Preparing for an inventory appraisal

The appraiser values what the records show, so the records are where preparation pays off. Before the visit, have ready:

• An inventory listing at item level, with cost, quantity, location and the date each item was last sold or received
• Sales history by product line, with gross margins, so the appraiser can see what sells and at what price
• The company's own reserve for slow-moving and obsolete stock, and how it is calculated
• Any consigned, customer-owned or bill-and-hold goods, identified separately
• A list of every location where inventory sits, with who owns or leases it
• The results of the last physical count and the size of any adjustment

Two habits help most. Writing down or clearing dead stock before the appraisal stops it from dragging down the recovery rate on everything around it. And explaining the business's actual channels, who buys what and at what discount, gives the appraiser real evidence to use in place of conservative assumptions.

A lender considering a new line also asks for the AR aging by customer, AP aging, balance sheet, P&L, year-to-date P&L, a debt schedule showing existing liens, and the inventory report. Transparent's book holds 235 lenders writing asset-based loans and lines, and they do not all value inventory the same way: some lend against it readily, others give it little credit. Knowing which is which is part of placing an inventory-heavy line.