When selling a business, maximizing value is of primary importance to the business owner. One element that can drag down business value is poor inventory management in the form of excess inventory. Maintaining proper inventory levels is essential to maximizing value.
When running a business, the goal should be to tie up as little cash as possible in inventory, while having enough inventory to meet ordinary business needs. After all, a prospective buyer looking at your business as a possible acquisition would rather have fully flexible cash not less flexible inventory weighing profits down. Any additional dollar that can be found to help bottom line earnings when selling a business will be rewarded by a higher price when the business is sold.
There is a delicate balance where it begins to cost more to carry the inventory than it costs to not carry the inventory. Carrying unneeded inventory can decimate profitability and cash flow in a hurry. Not only does excess inventory tie up a lot of cash, but there are day-in and day-out costs associated with that inventory as well. From the expense of financing that inventory, to the costs of markdowns due to age and obsolescence, to the incremental payroll costs of moving it around, to the hidden costs of not being able to merchandise more productive inventory in its place, it all adds up, and hits the bottom line.
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These costs affect the profitability of the business and include, but are not limited to, the following:
- Cost of Capital – There is a cost of the capital that you have tied up in inventory which may be in the form of interest that you are paying for the financing of the inventory. With every sales transaction, cash is generated, which drives the operating cycle. Cash is used to purchase inventory and pay expenses. But when your inventory is too high, your cash is tied up in that inventory. In cases where inventory is not being converted to cash efficiently, the need for an increased line of credit is the consequence. Paying more interest on the increased debt is obviously costly when you should be generating those funds internally.
- Storage – There is a cost for taking up space in a warehouse. You may be leasing more space than you actually need. You may also have higher utility expenses that are associated with leasing this larger space.
- Handling – There is a cost associated with servicing and maintaining inventory such as material handlers and record keeping staff.
- Opportunity Costs – This cost is associated with the funds you have tied up that you cannot put to use elsewhere. This cost can be determined by evaluating what you could have done with the money if you hadn’t spent it on inventory – whether it is investing in upgraded technology, equipment, staff, or something else you could have done with that money. Any higher gains that could have been achieved from those other investments is a lost opportunity and is a cost of carrying inventory.
- Insurance and Taxes – You may be paying more taxes and higher insurance premiums than necessary to maintain excess inventory.
- Risk of obsolescence – There is increased chance for obsolesce, deterioration, or damage when you have too much inventory.
- Higher Selling and Advertising Costs – If you are carrying an excess level of inventory, you will incur additional and probably unplanned selling and advertising expenses in order to sell the excess merchandise.
There are other issues concerning inventory that can derail the successful sale of a business. Be sure to discuss any inventory issues you may have with your merger and acquisition advisor prior to marketing the business for sale