A few years back the JPAbusiness team facilitated the sale of a business involved in import and distribution.
It was a well-known, independent brand that had been established for well over 50 years and had solid bottom-line performance.
Unfortunately, when it came time to exit the business, it soon became apparent there was too much inventory (stock on hand).
We negotiated a price for the goodwill, plant and equipment etc, based on a multiple of Business Maintainable Earnings (BME), which is essentially the cash flow of the business.
Then it was time to address the stock value.
Parties disagree over value
Usually stock on hand is valued by way of a stocktake and its value is paid by the purchaser at completion.
Ideally, its agreed value is the buy price the vendor paid for the stock at the time of the original purchase.
In this case there was considerable disagreement about the value of the stock on hand – a difference of 50%.
The buyer basically said: “You have X amount of stock, but a reasonable level of stock to run this business is Y. I don’t need X amount so I won’t pay for it. I will pay for Y.”
How it impacted the bottom line
This disagreement hurt the vendor’s bottom line in two ways:
- It represented a large reduction in the value of the business on exit – several hundred thousand dollars;
- It meant the cash flow the owner had diverted to stock holdings over the years was lost – he couldn’t get that value back out.
This experience was a timely reminder to me: “Don’t forget to actively manage your inventory, because there’s big dollars to be won or lost there as a business owner.”
Manage inventory like a share portfolio
Inventory can provide positive cash flow, but only if it is managed like a share portfolio.
For example, most people who have shares will actively look at what those shares are worth on a daily, weekly or monthly basis to see how they are trading versus the market.
If the shares are underperforming, they will be sold.
Similarly, inventory must be closely managed and moved on when necessary.
Don’t be tempted to sell off excess stock quickly
Simply planning to reduce your stock level just before selling your business is not a good option.
This will reduce the margin on the items sold and create a sudden reduction in your gross profit, which will negatively impact the Business Maintainable Earnings (BME).
As we've discussed in other eBooks, BME is a key consideration when assessing business value.
Rather than losing money on the stock, you will lose money from the business price.
If you have over-stock or obsolete stock items, they must be sold off gradually, over an appropriate period of time.