California Business Brokers

Avoid making the mistake of bad inventory management when selling your business!

Inventory has a significant impact on business value and business sales. It’s definitely the Goldilocks factor — you neither want to much nor too little of it because it can derail a business sale if not properly handled.

The longer inventory is held by a business, the more the value of it plummets. To be sold as part of a business sale, inventory has to be salable which means that it is no longer stale, out-dated, no longer trending, etc. If the business owner is not turning their inventory over consistent with their competitors, then inventory begins to clogs cash flow and drains capital.

If the seller is looking to sell in a year or so, the seller can augment the value of their business by dumping poorly performing inventory through clearance sales and securing better performing inventory to show more robust inventory turns. The goal for most businesses is to commit limited capital to inventory turns while assuring sufficient inventory levels are available for sale. Where free cash flow can be found to improve bottom line earnings, the business seller will be rewarded by a higher business valuation and sales price when the business is sold.

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Most inventory-rich business sales indicate a separate inventory purchase price. The price will fluctuate based on the wholesale inventory on the date of sale. When buying a business, buyers will perform their due diligence on inventory turns. If they deem that inventory turns are sluggish, this is a red flag that the business is not doing well. Consequently, it is imperative that the business seller 1. eliminate non-sellable inventory and 2. liquify sluggish inventory prior to putting their business on the market for sale. Prospective business buyers will be turned off from a business that has inventory weighing profits down.

Excess inventory negatively impacts profitability and cash flow. It needlessly ties up capital and operating costs in a number of ways such as: The cost of financing that inventory, the costs of markdowns due to obsolescence, the increased payroll costs of logistics to move inventory, additional costs of marketing unsellable merchandise, etc. These expenses reduce the bottom line of the business which, in turn, reduces the business valuation and the eventual business sales price.

Proper inventory levels is essential to maximizing the value of your business. 

California Business Brokers

The following costs are typically associated with excess inventory. These costs affect profitability and impact business value.

Capital Costs
When your business has bloated inventory, that means your capital is unnecessarily tied up. When inventory is not being sold, then cashflow is being stopped up which forces business owners to increase their lines of credit to make up for the blocked income stream. Increasing lines of credit causes the business owner more expense via additional interest payments.

Higher Selling and Advertising Costs
When a business owner has excess levels of inventory, they will often ramp up advertising to offload their inventory through various marketing and sales promotional channels. These marketing efforts increase the owner’s advertising costs.

Opportunity Costs
Due to the capital locked up by excess inventory, the business owner is unable to pursue other opportunities without incurring additional financing costs. The business owner may then have to delay making improvements, deferring maintenance, delay hiring and a variety of other improvements that helps a small business thrive. Obviously, these delayed improvements also delay the profits that would be stimulated by these improvements.

Insurance and Taxes
Excess inventory also influences an owner’s tax exposure and increases insurance costs.

Risk of Obsolescence
With prolonged There is increased chance for obsolesce, deterioration, or damage when you have too much inventory.

Carrying Costs
Long-term holds on inventory increase carrying costs such as storage, labor to transport and relocate the inventory, maintenance fees, security costs and administrative expenses to maintain records on the inventory.

Where the owner has no room on their premises to store the excess inventory, they may then be forced to lease additional storage space. This creates a losing proposition for the business owner who is now stuck paying to store inventory that they can’t move through ordinary sales. Unless there’s a very good reason to retain the inventory in storage, the owner would be better off liquidating and taking a short-term loss rather than incurring long-term expenses for products of questionable value.

Like Kenny Rogers sang, “You’ve got to know when to hold ’em. Know when to fold ’em. Know when to walk away and know when to run. You never count your money when you’re sittin’ at the table. There’ll be time enough for countin’, shen the dealin’s done”. The same holds true for holding inventory. It should be obvious that excess inventory is harmful to both a business’ bottom line and to the value of a business for sale. If inventory issues are not addressed prior to the sale of the business, these issues often undermine a successful business sale. Prior to marketing a business for sale, the business owner would be wise to liquidate unsellable inventory before it affects the business valuation and desirability of the business to a prospective buyer.

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