Preparing for Business Sales with Consistent Inventory Verification

Why Inventory Verification Matters in a Business Sale

Most small business transactions are structured as cash-free, debt-free deals that require the seller to include a normalized level of working capital to sustain the current revenues post-closing. The most significant elements of working capital are receivables, inventory, and payables, with inventory frequently being the largest component.

As part of due diligence, buyers will insist on inspecting the inventory. Any write-downs the seller may take due to excess or obsolete inventory could result in adjustments to the sale price. For a broader perspective on how valuation is determined, see

What Sellers Should Expect During Due Diligence

In a business sale, due diligence refers to the thorough investigation process a potential buyer undertakes to verify the financial health, operational details, market standing, environmental impact, and legal standing of a company before committing to a purchase. This process allows buyers to inspect and identify potential risks or liabilities associated with the acquisition by reviewing documents, conducting site visits, and analyzing data. As part of due diligence, buyers will ask detailed questions about inventory and expect sellers to provide comprehensive reports regarding both the quality and performance of their stock.

Cycle Counting: How It Works in a Business Sale

A robust inventory management system should be in place to ensure accurate, usable inventory records.  Such systems consist of perpetual inventory software and a mechanism for physical verification.  For physical verification, most lower middle market businesses rely on either cycle counting or physical count for inventory management.

How Cycle Counting Works

The company continuously counts small portions of its inventory while ensuring all SKUs are counted within a fixed period.

Consider a company with 1,000 SKUs where 20% of the SKUs represent 80% of inventory dollars, 30% represent 15% of inventory dollars, and 50% represent 5% of inventory dollars. The counting methodology stipulates that A items will be counted four times annually, B items twice annually, and C items once annually. This approach allows all 1,900 required counts to be completed with just nine daily counts.

Companies may choose from various cycle count methodologies, including Pareto, Usage, Physical Area, Random or Hybrid approaches.

Companies using cycle counting typically work with internal or external auditors to ensure their methodology remains dependable over time. If cycle counting delivers accurate results, auditors and accountants may accept these counts in place of a physical inventory.

What Buyers Should Look for in Cycle Counts

Buyers considering acquiring a company that uses cycle counting should understand the methodology employed and inspect cycle counting results over a significant period. Depending on their findings, buyers may accept the inventory level as reported, accept a portion as reported, or insist on a physical count of the remaining balance.

Physical Inventory Counts: Challenges and Buyer Expectations

In a conventional physical count, companies may suspend operations for several days to count every single item, including raw materials, work in process, and finished goods. Small companies often find the effort involved in executing an annual physical count manageable and see no compelling reason to change. Physical counting is typically scheduled at fiscal year-end, with the goal of making any necessary adjustments as part of the year-end closing process and starting the new fiscal year with a clean set of books.

What Buyers Should Inspect in Physical Inventory Counts

Buyers looking to acquire a company using physical inventory counting will first want to understand the company’s physical inventory counting history: How often were counts performed? What were the results? What adjustments were made? Once these questions are answered, buyers may accept the inventory as reported or request a full or partial physical count.

A full physical count can be a daunting task requiring temporary shutdown of operations. Moreover, in high-SKU environments, such requests may be impractical.

One potential solution is to separate SKUs into categories and apply different counting methodologies:

Inventory Count Process:

• Identify and physically count 100% of the A items
• Identify a representative sample of B and C items and count those items
• Prorate the results of the B and C sample counts to all remaining B and C items

Inventory Challenges in Process Industries

Measuring Bulk or Irregular Inventory

Businesses in the chemical, plastics, recycling, or similar industries maintain inventory in tanks, piles, or other vessels.  The importance of accurate inventory remains, but the methods differ significantly. To maintain accurate historical records, this inventory should be measured and recorded periodically, preferably monthly. While factors vary by industry and material, key measurement criteria should be established:

• Volume of a vessel or pile – calculated using the appropriate formula for the given shape
• Density – in piles of metals or plastics, note the varying density profile, which tends to be higher at the bottom
• Concentration – some materials have varying amounts of key components within a discrete object or slurry

Preparing Inventory for Buyer Due Diligence

Proper inventory verification is essential for a successful business sale. Whether using cycle counting, physical counting, or specialized methods for process businesses, maintaining accurate records and being transparent about inventory quality will help ensure smoother negotiations and better outcomes. Learn more about valuing your business and our proven approach through sell-side M&A services.

To dive deeper into preparing inventory for a sale, read our companion article, Managing Inventory When Selling Your Business. Together, these guides give business owners practical steps to avoid surprises and protect value in the sale process.