Inventory management is inconsistent in SMEs both in books and in real life on the shelves.
On the books – some companies keep a high level of inventory so as not to hurt their ratios, some manage inventories to optimize taxes, and others will depreciate their inventory over a few months even if the products do not expire.
On the shelves – some customers maintain high inventory levels “in case someone needs it one day…”, or simply because they don’t have time to clean up. At the other end, there are companies where everything is coded, tracked in real time with a link to the accounting system.
Inventories are key in a sales context. If the level is wrong – it is the profitability of the company that is affected, as well as the level of working capital, therefore: the valuation of the company is negatively affected.
When the products in inventory are not fluid (regular sale, at normal price), a buyer will not give them value. It is therefore important to monetize this aspect before or during the transaction. Here are some examples:
- A customer who had $500,000 worth of potentially “obsolete” inventory from a line he did not like. Once the problem was raised, he assigned a manager: the inventory was sold at a profit and the line of business was restored.
- Another manufacturer used liquids in their formulas. Since the price was cheaper per gallon, he ordered some for the various ingredients. The problem is that the usage was in tablespoons per month…the valuation of an inventory that is in place for the next 10 years is questionable…will the product still be good? will I still need it? How much does it cost in storage?
- At the manufacturing level, scraps, residues of parts and components can sometimes be reused. The challenge is when the seller assigns a value to those scrap that are kept “just in case”, and one should also ask about the costs associated with selling those parts, etc.
In short, the inventory is a question of dollar: as much to properly assess the EBITDA – therefore the valuation of the company, as the amount of working capital that will have to be available during the transaction and which may be the cause of adjustments monetary.