When selling a business, maintaining proper inventory levels is essential to maximizing value.  Don’t let poor inventory management drag down the value of your business. 

Inventory is an ever-renewing, moving, and perishing thing. The longer it hangs around, the less valuable it gets, and eventually dies as a viable product.  If it’s not turning over fast enough, the inventory begins to stop-up cash flow and drain capital coffers. Inventory is a dollar-for-dollar part of the buying and selling process and buyers will make a close assessment of it prior to closing a deal.

So, when operating a business, the goal is to tie up as little cash as possible in inventory, while having enough inventory to meet ordinary business needs. And, when selling a business, prospective buyers looking at your business as a possible acquisition would rather see fully flexible cash, not less flexible inventory weighing profits down. Any free cash flow 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.

Regarding the problem of excess inventory, there is a delicate balance where it begins to cost more to carry the inventory than it costs to not carry the inventory. Supporting unneeded inventory can decimate profitability and cash flow in a hurry. Not only does it tie up a lot of cash, there are day-in and day-out costs associated with that inventory as well. Whether it be the expense of financing that inventory, the costs of markdowns due to age and obsolescence, the incremental payroll costs of moving it around, or the hidden costs of not being able to merchandise more productive inventory in its place, it all adds up, and hits the bottom line.

The following costs associated with excess inventory affect profitability and impact business value:

Cost of Capital
There is a cost of the capital that you have tied up in inventory. With every sales transaction, cash is generated, which drives the operating cycle.  That 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 may be the consequence. Paying more interest on the increased capital requirement 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 invest 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 or outdated 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 business broker prior to marketing the business for sale.