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Beware of Manufacturing Cost Accounting

When selling to a manufacturer in the Aerospace and Defense (A&D) industry, among the many details that you need to consider is the accuracy and consistency of your product cost accounting. Buyers will scrutinize your gross margins and the true cost of goods sold (COGS).

If you, like most manufacturing A&D companies, use a standard costing system, then your standards need to be reviewed and updated regularly to accurately reflect your product costs (labor, material, processing, etc.) and be as close as possible to your actual costs. As M&A bankers who represent the sellers of middle market A&D companies, we often find companies that use a standard costing system leading to attractive gross margins. Subsequently, we discover that substantial cost variances have been allocated to inventory. This then leads to overstated inventory values, undervalued cost of goods sold, and erroneously high gross margins.

As we mentioned in Deal Note® 67, during buyer due diligence you can be assured that inventory accounting issues will be identified for both inventory and product cost inaccuracies. Product cost accounting done incorrectly or inconsistently will almost always lead to a significant reduction in the purchase price, post Letter of Intent.

In summary, well in advance of selling your A&D manufacturing company, be sure that your team has been accurately and consistently costing your products and that you can defend your gross margins and the value of your inventory when buyer due diligence occurs.

Have a great day.

Bruce Andrews
Managing Director, Defense