Managing inventory is one of the most overlooked steps when preparing a business for sale. Here’s what distributors and manufacturers need to know.
For most distributors and many manufacturers, inventory represents a major component of their assets and figures prominently in operating profit calculations. When considering selling your business, managing inventory becomes crucial. Too often, we have seen poor inventory practices negatively impact both the salability and value of businesses. Fortunately, managing and resolving inventory issues is not complicated.
Inventory Matters in a Business Sale:
Key points to consider
Accurate Records
Maintaining accurate inventory records is essential. Knowing what you have on a real-time or monthly basis becomes especially important as a sale approaches. During a sale, inventory will be part of the negotiations around net working capital targets. Buyers want to understand historical inventory needs and expect to know exactly what they are purchasing at closing. This includes having an accurate locator system to track inventory efficiently. Learn more about inventory verification.
Matching Balance Sheet Values
Ensure that your inventory control system values match the values on your balance sheet. This alignment is critical for providing a clear financial picture to potential buyers. When inventory on the balance sheet is incorrect, operating profit calculations become inaccurate, which could cause delays since two accurate year-end inventories are needed to determine true profit. At the time of sale, under-reported inventory will create a gain on inventory that will be taxed at ordinary income rates.
Minimal Obsolete Inventory
At minimum, identify obsolete inventory early in the process and, if logical, clean out and write off any obsolete stock. This step helps present a more attractive inventory profile to buyers and avoids potential price adjustments during the sale process. Note that obsolete and slow-moving inventory can create the appearance of requiring more inventory investment than is actually necessary.
Identifying Slow-Moving Inventory
Identify slow-moving inventory and disclose it early in the deal process. Determine whether it is needed and provide a clear rationale for its presence. Sometimes slow-moving inventory is necessary for specific business models, and in these cases, this must be communicated early to avoid surprises later in the process. Purchase agreements often include provisions for price reductions related to obsolete or slow-moving inventory. Being proactive virtually eliminates this possibility.
Customer Deposits
Account for customer deposits, particularly in job shop environments. This is typically managed through a jobs over/under billing report that shows the status of each open job. This ensures that all financial obligations and assets related to open jobs are transparent and properly accounted for during the sale.
Managing Excess Inventory
Avoid carrying excess inventory except in special circumstances. There are times when excess inventory is necessary or makes sense, such as during the 2021 supply chain challenges caused by the COVID pandemic or the 2025 tariff wars. Convert excess inventory into cash and provide an accurate picture of the required investment in inventory.
Avoiding Stock Outs
Ensure that you are not carrying too little inventory, which can lead to lost sales due to stock-outs. Maintaining optimal inventory levels is crucial for sustaining business operations. Utilize a robust inventory management system capable of demand forecasting, safety stock calculations, and triggering stock reorders.
Work In Progress (WIP)
Include WIP in your inventory calculations. The criticality of WIP depends on how much it fluctuates and the materiality of its value. Buyers expect to acquire a normal amount of work in process. Identify specific WIP that includes nearly finished products waiting for bottlenecked parts or some form of outside analysis or approval. In some cases, this should be discussed as a separate item in business sales.
Measuring Inventory Turnover
Measure your inventory turnover and compare it to industry standards. This metric helps assess the efficiency of your inventory management and provides valuable insights to potential buyers. Most importantly, it informs management whether they may be investing too much or too little in inventory.
How Strong Inventory Practices Increase Value in M&A
By following these guidelines and avoiding common inventory pitfalls, you can present a more attractive proposition to potential buyers and facilitate a smoother sales process.
Preparing Your Business for Sale
If selling your manufacturing or distribution business is on the horizon, whether soon or years away, our advisors can help you prepare. From inventory and financials to operations, we provide guidance that helps you protect what you’ve built and position your company for maximum value. For more information, contact us at BMI.
Frequently asked questions
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Why does inventory matter when selling a business?
Inventory is often a major component of assets in manufacturing and distribution companies, and it directly impacts operating profit and business valuation. Accurate inventory management helps avoid surprises in due diligence and gives buyers confidence in the value they are acquiring.
What inventory records should be prepared before a sale?
Sellers should maintain accurate and up-to-date inventory records, ensure inventory values match the balance sheet, and identify slow-moving or obsolete items early. Clear records help prevent delays and adjustments during negotiations.
How does obsolete inventory affect valuation?
Obsolete or slow-moving inventory can reduce the attractiveness of a business and may lead to purchase price adjustments. Addressing and disclosing it early in the process minimizes surprises and supports a smoother transaction.
Should customer deposits and work in progress be included in a sale?
Yes. Customer deposits and work in progress (WIP) are important components of a company’s financial obligations and assets. They should be accurately accounted for and disclosed to ensure transparency during the sale.
How can inventory practices increase business value in M&A?
Strong inventory practices, such as optimal stock levels, turnover tracking, and minimal excess inventory, make the business more attractive to buyers. These practices reduce risk, improve efficiency, and often support a higher valuation multiple.