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If you’re running a product-based business you’re dealing with inventory. Inventory management has a direct impact on the profitability of our business.
How easy it is to transfer not only our physical inventory but the processes, sources, and relationships that power our inventory will have a direct impact on how the value a potential buyer will place on our business.
At first glance, you might think inventory is one of the easiest parts of a business to put a number on when you’re getting a business ready to exit.
Or is it?
Businesses are bought and sold based on the perception of future value.
Business owners are often experts in fields outside of business.
We developed Business BeyonDIY to help you cross that chasm.
Show Topics:
Buying a Business
Selling Your Business
Preparing Your Business for Sale
Practical | Actionable | Sustainable
Business owners and entrepreneurs are go-getters. We start things other people don't (sometimes too many things am I right?) and we push through hard times. That means that entrepreneurship involves a lot of DIY.
Some of the most important transactions we make are buying a business; preparing a business for sale and selling a business. We'll almost always want/need help to make these successful but there is still a lot we'll need to do ourselves.
Business BeyonDIY is a Livestream/podcast where we own our DIY nature but find that sweet spot where doing it yourself doesn't mean going it alone.
In this introductory episode, I'll let you know the format of the show, what to expect, and when I'll be live.
I'm looking forward to getting to know you and your business and sharing practical tips that will make your DIY more like DI-Us!
Stephen Krausse
If you're a product based business, your stock on hand or inventory as likely shown on your balance sheet is probably one of the most valuable things you have on that balance sheet. At first glance, it might seem like one of the easiest parts of your business to place a value on when you go to sell it. And after all, there's a line item on the balance sheet that says inventory, right? Well, today we're going to explore why it might not be quite that easy, and how to approach inventory as a buyer, and how to put your best foot forward as a seller when it comes to your inventory. Hi, business owners and entrepreneurs I'm Stephen Krause. See with beyond 50% Welcome to Business beyond DIY, where if we get you from here to what comes next. As I said, I'm your host, Stephen Krause II and love business. And I want to help you get the most from your entrepreneurial journey. Business beyond DIY is about understanding and developing the value of business, your business. So let's get started. Okay, so one of the things I was complaining about in the last show was that I couldn't see my notes because of the software I used to run the show. And then I realized I could just put my notes on a different thing. So I always like to share I know it sounds it's kind of off topic. But I always like to share the things about producing video that I learned just in small tidbits, because video is becoming such an important part of how we communicate with our marketplace, or even with our team members. So the more we can do, you know, the more we can share with each other, when we when we find something, I think it just makes everybody you know, it gives everybody one more thing that they can do a little bit better next time. So if you're doing video for your business, if you're not doing video for your business, I would encourage you to explore it. If you are doing video for your business. That's why I come up with these little things that I share. When I do, as I'm doing this, there are a lot of great resources out there to you know, to encourage you or to educate you on how to do video. That's just one little tip. Sometimes your software, I don't want a big dual screen setup here. So I can have the green for the streaming software, and then a screen for my my notes. But of course I say that but I have a dual screen here because I've got the operating software on one and then my iPad. So maybe that's kind of silly. Anyway, what this will allow me to do though is in the future, I may actually move the computer off of the desk. So the only thing I have here is is the screen with my with my notes on it. So just a little tidbit there. So why do we care? Let's get back to inventory. Why do we care about even talking about the value of inventory? I mean, there is literally a line item on your balance sheet that says inventory. And why can't we just use that? Well, as it turns out, there are a few more pieces of the inventory puzzle that we need to think about as buyers. And so as a seller, we need to think about what is the buyer going to be looking for, for a buyer, there are three basic things that are going to come up with inventory. One, what am I buying? And that's the figure that you might have on your balance sheet. And we'll talk about why that might be a might question in a moment. What am I buying? That's the first thing. Second thing? How do I get more of it? So and then the third thing thing is, is it useful to me. And we're going to talk about each of these things in detail because they matter to the valuation of your business, as a seller, and they matter to your analysis and your due diligence of a business as a buyer. So they really do make a huge change, kind of to put a longer description on that. What am I paying for? And we want to make sure that we're getting that if we're a buyer, and that's the you know that first one of what am I buying? Secondly,
is this inventory going to be useful? And am I going to be able to get more of it? Do I understand the supply chain? Do I understand? Who are the vendors? How long does it take etc. So we'll talk about that. And then is the inventory that's on hand consistent with my vision of the future of the business. And that is another piece of the puzzle on the buyer side and as a seller, we need to understand how a buyer is valuing our business and look at how can we demonstrate that in a way that is as effective as possible. So those are the things we're going to be looking at as a buyer as a seller and I kind of hinted to this, we're gonna want to maximize the value of the inventory we have on hand because it's part of the value of our business. And we're going to want to look at what the buyers needs are, and try to, to meet those expectations. And so we're going to go through all of that this morning, talking about each thing. So first thing, what am I buying as a buyer? What am I buying? And so there's two pieces that go into this one is the actual value. And we're going to talk about some valuation methods here in a few minutes. But but the value the the financial value of the inventory itself, and then the validity of the data in the system that we use. So you have a balance sheet that says your inventory is worth $100,000. How confident am I as the buyer, that that's a real number. And that's important. So let's first of all, let's talk about the value of the balance sheet value. Or, let's talk about what that looks like. It's easy to see we like it, we like it, because it's an easy number to get ahold of to grasp onto. Right, it's also easy to validate if the system is well maintained. So if you're a product based business, and you're using software and application to do your accounting, and you're using purchase orders, and invoices and receiving processes, so that each step of the process allows you to say, Okay, I ordered 100 units from a vendor, those came in, they were checked in, they were put away. And that's reflected in my inventory balance. And the cost if you're using first in first out or FIFO, that is reflected in your accounting system as well. Where this can fall apart is if a any of those steps are missed. If you don't use purchase orders, if you just have deliveries come in, and you just put them into inventory as an inventory adjustment, and enter the bill to the vendor a different way. Or if you're using a cash based inventory system where you're paying cash for inventory, and just using an adjustment to add on in your system. Or if you don't have an accounting system, and you're using a spreadsheet, all of those things may be perfectly valid. And they may work fine. And that's okay, I don't want to suggest and again, and I am a big advocate, you've heard me talk about this before, I want you to use systems that work for you in your business. What I will tell you about this is that using a system that is easy to validate, makes it easier to transfer to a new owner. And that has value. So the easier it is for me as a buyer to see myself adopting your system, the fewer obstacles there are to that the more valuable I am going to perceive that system. And that matters when you're trying to exit. So, you know, that's what we're talking about when we're talking about simply the balance sheet value, what's going to be on that balance sheet figure, or what's going to be incorporated into that is automatically generated if your system is is done start to finish. Using the right procedure, I shouldn't say right procedures, but a more formal procedure system. And so it matters.
Retail value is not commonly used. Because normally when we buy inventory, when we buy a business, we're going to want to get the retail value as the new owner. So don't expect someone to come in and say and you're buying something at $50 apiece, and value it at $97 A piece because that's what you sell it at. That's not realistic. I've never seen that be something that is incorporated into a business purchase. And I just wanted to touch on it in case there were any questions typically those the value of inventory in a business transaction, when it comes to buying a business, it's going to be the it's going to be based on the balance sheet value, how much you paid for that product, versus what you consider the retail value to be. So that's just something I wanted to mention. liquidation value is is another one where we're looking at how much this is going to be worth if I dump it all immediately. Meaning that I take everything that you have an inventory and I find a liquidator or somebody that will buy it, or I throw it all on Amazon or eBay immediately. What is that going to be worth? This is typically used more when you're doing an asset sale when it's something where you're not, we're not really talking about the continuity of a business per se. We're talking about getting rid of the the assets, and that can have a perfectly valid place in a business acquisition acquisition situation. So don't discount it necessarily. But when you're buying a business that you're expecting or selling a business where you expect the buyer to continue operations as that business typically that's not going to be the valuation method that so Certainly as a seller, you're going to want to see, you're going to want to see them using the balance sheet value or something close to it. So I also put a note in here about what I call continuity value. And I'm going to talk about this a little bit more as we go through. But that is the value that you're going to assign something. When you're going to continue operations, like I said, as a new business, or as a new business owner, you're going to continue operations largely as the same company. That isn't always the case. Sometimes a buyer will buy a company for other purposes than simply to run it you can you've seen acquisitions to simply remove a competitor from the marketplace, you can have an acquisition, that is more based on maybe the assets of the business are more valuable as assets to another party, then the business is worth as a continued operation for the current owner. And that's where you get into a liquidation situation. All of those things are fine, and different. And so what we want to understand as sellers is where's the buyers head at? Are they thinking about approaching this acquisition as a continued operation? Or are they looking at it as Oh, I'm going to take these three parts and use them in this new way. And the rest of the businesses is going to discontinue operations. And that happens. So it's something to think about, it's not necessarily going to be a value of the specific inventory items, but it will affect the overall value of your inventory as a whole. So I wanted to just touch on that a little bit. So after we get the number, you know, whether it comes off the balance sheet, or whether it's a liquidation value, something like that, or some combination of the two, then we get into
how well do we believe the data. So as a, as a buyer, do, I believe that your finished goods and raw materials data in terms of quantity is accurate. And there are a couple of ways to do this, obviously, you can do a full physical inventory. And say, you know, and I'm not going to get into how the contract would would cover this, you know how the how the sales agreement would cover this, but you can incorporate a physical inventory into into that. And then that physical inventory becomes an adjustment to the total price. Once the real number is known. You can demonstrate as a seller, you can demonstrate a history of physical inventory reports that show that you have done physical inventory, you have counted your inventory on some regular basis and made adjustments to assure that your numbers are accurate. And then the other piece of that is perishability. So if you're buying a business that has inventory that's perishable, whether that's a food, a food based business, or some other business with perishable raw materials, maybe you have chemicals that are used in your business, and those have a shelf life that needs to be understood by the buyer. And certainly if I'm the buyer, I'm going to be looking at this and saying how much impact is the perishability of this inventory going to have on my ability to move from the day that I take control to having a fluid process in place to continue operations and that may be two days it may be two hours, it may be two months? And how does that affect? Or how does perishability affect that particular aspect of the business arrangement. So perishability will also enter into the inventory discussion. And then we have storage requirements. And this is not necessarily going to impact the value of your inventory. But it is an important thing that your buyer needs to understand when it comes to buying your business is how do they how do you store and organize your inventory so that it's useful in production and production can be making a cake or it can be making as we used to make it directed energy high voltage pulse generators. So that's still production. And when we talk about storage, or the special requirements for storage, refrigeration, hazardous material storage, all of those things come into play. You know, in the case of directed energy we at the peak of producing on our own we had 1000s of raw material components different values of resistors, different values of capacitors, hardware components, printed circuit boards, integrated circuits, transistors, and the list goes on and on. And all of those had to have not only individual bends so that we could keep track of them. But also, for example, the integrated circuits needed to be protected from electrostatic discharge or ESD. And so we did have specific storage requirements for some of the raw materials. And that can, that's just one example of the requirements that your buyer is going to need to understand to assign value and get comfortable. Remember that that when you sell a business, it isn't just about arriving at a number that you can say this business is worth X, in order to get a buyer to sign on the dotted line, they need to believe that they can push the business forward that they can continue operations as the new owner, and the more comfortable we can make them feel
the better and I don't mean make them feel like it's artificial. I mean, the more comfortable we can help them become it maybe is a better way of phrasing that. So they become more comfortable with running the business with continuing the business. And so when we talk about storage, how our inventory is stored, we need to be able to share that with them. And show them demonstrate to them that this is how it's done. And it has been done for a long time, not Oh, we put it to altogether two weeks ago in order to show it to you. But it's really we have minutiae very long as it's kind of sketchy, we want to be able to demonstrate that we've been doing this right for a long time. And that you can do it right to right, you can do this, being able to to share that and demonstrate that adds to the transfer ability of the business. And transferability is a huge, has a huge impact on how I perceive a business how I feel about it as a buyer, versus simply the valuation on paper. Let's talk a little bit about sourcing. That's the next thing that comes up. So we've talked about and we talked a little bit about sourcing earlier, but we've talked about how the actual value can be arrived at and some of the things that impact that value. Now let's talk about sourcing. Because this comes back to the the question I asked earlier on is how do I get more of this. And sourcing is an important issue when it comes to inventory. And now we're talking about the that continuity piece again, how do I see myself as the buyer, continuing this business, the first thing is, obviously, we're going to do a vendor review. So expect that if you're a seller, be ready to share the information with your vendor of your vendors or for your vendors, with your buyer, it naturally you're going to want to let your your vendors know, hey, we have somebody who's potentially going to buy this business, they're going to be talking to you, here's their contact information or whatever. I don't want to talk too much about this, but I will do is a show specifically about how to interact with vendors, customers and employees when it comes to buying or selling your business. Because it matters. So we'll talk about that later. But expect it. If I'm a buyer, or I'm representing a buyer, I am we're going to want to talk to your to your principal vendors. I guarantee it the vendor review and introduction, that's going to be something that you need to be expecting. cost versus order size. You know, that's something that as a buyer, I'm going to want to understand how many do you order at a time? How much do you pay for it? If I ordered twice as much would that give me some kind of financial break? Doesn't mean I'm going to do it. But I want to know what the options are. If you're buying something that doesn't get discounted in bulk, for whatever reason, then okay, that's something I want to know if it's something that is discounted tremendously in bulk, then I want to know that because if I can capitalize higher buying volumes, then I can reduce my cost as long as I can store it. So as long as I have the storage space and the and the ability to organize that much inventory. So that's a huge piece. Continuity of supply. So what am I buying and can I get more of it? And and are the vendors valid for me? And this is a shouldn't say valid I should say Are they going to have the same relationship with me that the current owner has with them. And the reason I say that is that if you have a vendor that really likes you, and has been giving you the cool guy discount for 10 years, and the business shifts, and my cost for that product as the buyer is double what you were paying for whatever reason, that changes the value of your product because your margins change. And that impacts the value of the business. So as a buyer, I'm going to want to talk to those vendors and get real answers from them about you know, is our relationship with you going to be the same as the relationship you had with the previous owner. And I want to understand that, so that's going to matter, the supply chain side of it has an impact on the inventory value. And is something that you need to be thinking about. Finally, there's this do I care portion
am I going to continue every single product in a product based business that the prior owner can had running, when I buy it. And as as the existing owner, we might really want to be attached to the idea that a new buyer or new owner is going to do everything the same as we have done it or we're gonna have this continuity. Honestly, that's really unlikely. Most of the time when someone buys something, they and I've said this before they buy it because they see a future for it, that the current owner isn't implementing or doesn't see doesn't have the skills to to or knowledge to enact or implement. And that doesn't say anything negative about the current owner. And I think it is so important. I've talked about this before, and I will talk about it again, just because you're not the person to move this business in this direction, or move it to an to another place where it can add additional value to the economic environment doesn't mean anything, in terms of who you are, how successful you've been. Okay, I want you to just let all of that go. When you're selling a business, you're selling it because you have something else you want to do. And you have the opportunity to sell it to someone extract value yourself and provide value to somebody who has a vision to take that business forward in a new way. Now, it's possible that you could sell it to someone who's going to continue to do it just exactly like you have, because you're retiring, and you're just ready, that's possible. But probably not likely that the business is going to stay exactly like it was under your ownership. And that's okay. In fact, that's what we want. We want businesses to change and grow and try new things. And as owners, we want to be able to do that as much as we can. But we can't know everything. We can't be everything to everyone. And sometimes it takes a fresh perspective, from a new owner to create that kind of momentum in a new direction. I'll tell you a story. This isn't in my notes. But now that I brought it up, I was working on a deal with a business owner a number of years ago. And we agreed on pretty much everything in terms of the price of the business, the payment terms, the you know, whatever else was coming up. And that owner wanted to continue to work in the business. And I said no, I was nice about it. But I declined that offer. And that killed the deal I in conjunction with a couple of other part components or terms that I wouldn't agree to or that he wouldn't agree to. But that was one of the things that that I that was a no go for me. If that had been the only issue of contention, I still would have walked away from that deal. Because I had a vision for doing things differently. And you can't do things differently. If someone is they're constantly trying to keep things the same. And yes, it is possible that an existing owner could just let it go and let the new owner do these new things and really be supportive and and really back the change. That hasn't been my experience. And that doesn't mean it can't happen. But it hasn't been my experience. And so that's an example of where you know, we just had to say no, because I I couldn't go there, I needed, you know, to be able to put a new direction on some of the programs or some of the things we were doing in the business. And so for me, it was a no go. But my point is it matters. And the vision of a company is based on what a new owner might want to do. And they have to be able to implement that. And you shouldn't, like I said, You shouldn't feel like that means anything less for you, as the existing owner. It's just a different thing. It's just a different way of doing things. So So let's kind of just wrap up everything we talked about on the buyer side, and we can sort of sum this up in into a few points for each person as takeaways. On the buyer side, what am I buying? Okay, and that kind of goes into that is your balance sheet number? Can I get more? That's your supply side number, that's your are your supply side sourcing. And then is it part of my plan.
So I'm not going to buy something that I'm or I'm not going to add value to something that I'm not going to continue as the new owner, because that doesn't have value to me. And so there may be 30%, I'm just making up numbers here, there might be 30% of the inventory, that is raw materials for a product line that I don't see a future for. I don't want to pay for that. And that's part of the negotiation process. Alright, so three things for the buyers. What am I buying? Can I get more of it? And is it part of the future of the business as I see it? All right. On the seller side, obviously, we want to get the most we can for our business, the best way to do that is to be able to demonstrate the value of your inventory and the accuracy of your inventory. With transparency. A well organized inventory system both in in in physical inventory, well organized on the floor, and well organized in your inventory system in your accounting software. Okay, and vendor cooperation, talking to your vendor saying this is going to happen. This is what I'd like or don't tell them what you'd like them to say but treat them well. So that what you'd like them to say is what they'll say, but but vendor cooperations so that the it as the seller, you can demonstrate not only the value of your inventory, but also the transferability of your inventory, and your supply chain, those are all going to increase the overall comfort that that buyer is going to have and the value they're going to assign to that figure. One last thing I wanted to look to talk about here is to always look at ways for both parties to win. When we go to buy a business, this is not about me getting the better of someone. We don't that is not the point of negotiation. It's not the point of the buying or selling position or process. It's understanding the value according to the buyer, understanding the value according to the seller, and finding common ground between the two, where both sides get what they need. If you're not getting what you need in a business deal. You need to find another party to work with, whether you're the seller or the buyer, if you're looking to buy a business, and you're not getting let's say I'm looking at buying a business and I don't want to buy that 30% of inventory because it isn't valuable to me. And the seller is saying hey, that's valuable. You need to buy it. It's okay to say no, this isn't and it's not. That's not an indictment of the seller. It's just saying this deal is not right. For me. And that's okay. Always look for both parties to win. There's no reason in the world both parties can't come out winners. Thank you for joining me on this entrepreneurial journey. I'm Steven Crowder with beyond 50% and I help entrepreneurs buy and sell businesses with an experience driven process and impartial analysis. Connect with me on one of the social platforms listed in the description below. If you're ready to get from here to what comes next, there's a link down there with my calendar so we can discuss your goals. If you found this video helpful, please like and subscribe. If you're listening to the podcast five star reviews, let the podcasters know that this show exists, that the content is relevant, and sometimes it matters. Thanks again. Remember, doing it yourself doesn't mean going in alone.
Transcribed by https://otter.ai