In the due diligence process prior to a sale, it’s rare for a physical count to take place before closing. What can be expected are questions about the reliability of inventory tracking methods of the selling company, as well as any known areas of concern (such as historical count differences).
Questions leaders should ask about inventory.
- How often is inventory physically counted?
- How much does the inventory count vary from related company records?
- What accounting adjustments have been made to inventory?
- Why were the accounting adjustments necessary?
Most manufacturing companies have a perpetual inventory system that keeps an ongoing count, but leaders should ask themselves if they trust the system. The double check can be a physical count.
If your method is a periodic full physical count, it’s important to do so as near the end of an accounting period. If you’re counting at year-end, try to count on Dec. 30 and adjust for any receipts/shipments that occur on Dec. 31. Or count on Jan. 3 and roll back activity to the period end. This minimizes the opportunity for errors to build up in the interim.
Another method is cycle counting, where a smaller group of items is counted each month (or week or even every day). Everything will be counted eventually, but the majority of each count focuses on key items. For example, items could be broken down by value into categories A, B, C and D, with all category A items counted each month, 50 percent of Bs, 20 percent of Cs and 5 percent of Ds. A cycle count is less disruptive to operations. For example, production and shipping departments don’t have to shut down as they typically would during a full physical count.
During the M&A process, a physical count typically takes place later as a condition to close and/or part of the working capital “true up,” potentially impacting the overall consideration exchanged for the business. The current or future accounting firm should be involved in this count to observe procedures and adjustments in order to rely on the inventory for opening balance sheet purposes.
Financially speaking, would-be purchasers view relatively high inventory levels as an immediate payback opportunity. If a buyer is able to reduce investment in inventory, they can pull out money in cash from working capital, which may affect what they’re willing to pay for the business. Building or maintaining inventory requires cash, so if the buyer could reduce the days of inventory on hand by five days, that could mean dollar for dollar payback.
Operationally speaking, inventory organization and stock levels provide insight into plant efficiency and potential costs post-close to train and upgrade people and processes. The prospective purchaser will want to know how much they will have to change when they take the reins, how much it’s going to cost and what the payback period is.