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In all our years of operation, I don’t think we have seen two businesses that manage their inventory the same way; so, it should not be a surprise when a buyer looks at your inventory differently than you do. Whether you are a save everything because it might useful later type of owner or an everything has a place and keep meticulous records type of owner, there are a few basics that you should know about the value of inventory to a buyer. Keep in mind that a buyer is purchasing an operational business and that includes your inventory.
Buyers only want inventory that they believe to be useful to operate the business post transaction – not anything they consider obsolete. Typically, that means the valuation is surrounding inventory acquired within the last year of operation. So, what do you do with it? It really depends on why you kept it in the first place. I had a seller who had a “bone yard” of old parts for systems that weren’t in production any longer. They kept several shelving units of the old systems they removed. Why do you ask did they do that? Well, they had a reputation for being able to service any system regardless of age. So they used this obsolete inventory – that was NOT on their balance sheet – to help get new customers who needed to upgrade the system but couldn’t have something not function while they were getting quotes. Knowing that, we were able to communicate negotiate with the buyer for additional “goodwill” in the purchase price.
Not all over stocked shelves earn you additional value however. If you have been collecting parts for the last 30+ years you may have a bunch of machined parts that no one needs. So, what can you do with obsolete inventory? When getting ready to sell your business it’s time to look at the inventory value included on your balance sheet and what’s on the shelf and see if anything can be cleaned up and/or sold. Is there an alternative use for it? Can you sell it for salvage? Is it more than you want to hassle with and you’d like to include it in the sale of the company just to be done with it?
Do I need a control system in place before I sell? If you want to optimize the sale of the business, then the answer is yes, you need some type of controls in place to monitor and account for the inventory. That includes your Work In Progress (WIP) inventory if your business manufactures things or is project based. You can accomplish this with packaged software and equipment, or just some extra leg work on your employees. If you are a growing company, it is worth it to get a handle on your inventory.
Which is a better way to account for inventory value FIFO or LIFO? First in First Out (FIFO) accounts for the items the company bought first to be sold first. If cost of raw materials are increasing it means keeping your highest value items on the balance sheet. Last in First Out (LIFO) accounts for selling the items you purchased last – potentially at a higher cost – to be sold first leaving you less inventory value on the balance sheet and a higher cost. If the economy turns to a recession, the advantage changes. Consistency within the years approaching a transaction is key. So, if you are contemplating a change, consult your CPA first to see the tax impact depending on the economic impact of inflation or recessionary costs. The variables involved in each business both operationally and tax implications means individualized assessment should be sought.
If you want to get the full value of the inventory, it will be necessary to be able to show the buyer what you have and how you manage it. How you value and control your inventory can make a difference if you are leaving money on the table during a transaction. Make sure you are working with your trusted advisors – your CPA, M&A Attorney and your Merger and Acquisition Advisor to create a deal that accounts for these nuances of your business.
In all our years of operation, I don’t think we have seen two businesses that manage their inventory the same way; so, it should not be a surprise when a buyer looks at your inventory differently than you do. Whether you are a save everything because it might useful later type of owner or an everything has a place and keep meticulous records type of owner, there are a few basics that you should know about the value of inventory to a buyer. Keep in mind that a buyer is purchasing an operational business and that includes your inventory.
Buyers only want inventory that they believe to be useful to operate the business post transaction – not anything they consider obsolete. Typically, that means the valuation is surrounding inventory acquired within the last year of operation. So, what do you do with it? It really depends on why you kept it in the first place. I had a seller who had a “bone yard” of old parts for systems that weren’t in production any longer. They kept several shelving units of the old systems they removed. Why do you ask did they do that? Well, they had a reputation for being able to service any system regardless of age. So they used this obsolete inventory – that was NOT on their balance sheet – to help get new customers who needed to upgrade the system but couldn’t have something not function while they were getting quotes. Knowing that, we were able to communicate negotiate with the buyer for additional “goodwill” in the purchase price.
Not all over stocked shelves earn you additional value however. If you have been collecting parts for the last 30+ years you may have a bunch of machined parts that no one needs. So, what can you do with obsolete inventory? When getting ready to sell your business it’s time to look at the inventory value included on your balance sheet and what’s on the shelf and see if anything can be cleaned up and/or sold. Is there an alternative use for it? Can you sell it for salvage? Is it more than you want to hassle with and you’d like to include it in the sale of the company just to be done with it?
Do I need a control system in place before I sell? If you want to optimize the sale of the business, then the answer is yes, you need some type of controls in place to monitor and account for the inventory. That includes your Work In Progress (WIP) inventory if your business manufactures things or is project based. You can accomplish this with packaged software and equipment, or just some extra leg work on your employees. If you are a growing company, it is worth it to get a handle on your inventory.
Which is a better way to account for inventory value FIFO or LIFO? First in First Out (FIFO) accounts for the items the company bought first to be sold first. If cost of raw materials are increasing it means keeping your highest value items on the balance sheet. Last in First Out (LIFO) accounts for selling the items you purchased last – potentially at a higher cost – to be sold first leaving you less inventory value on the balance sheet and a higher cost. If the economy turns to a recession, the advantage changes. Consistency within the years approaching a transaction is key. So, if you are contemplating a change, consult your CPA first to see the tax impact depending on the economic impact of inflation or recessionary costs. The variables involved in each business both operationally and tax implications means individualized assessment should be sought.
If you want to get the full value of the inventory, it will be necessary to be able to show the buyer what you have and how you manage it. How you value and control your inventory can make a difference if you are leaving money on the table during a transaction. Make sure you are working with your trusted advisors – your CPA, M&A Attorney and your Merger and Acquisition Advisor to create a deal that accounts for these nuances of your business.
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