Inventory accounting often receives intense focus during due diligence.
Buyers want to make sure they will have enough inventory at closing to allow uninterrupted operation of the business, but not so much that they are providing too much upfront cash or exposing themselves to obsolescence risk. And they will want to be sure the method of accounting accurately reflects the inventory’s value. Although Audited financial statements add a level of external confirmation, buyers will still conduct exhaustive due diligence. And if a seller only has Reviewed or Compiled financial statements, the perceived risks are obviously greater.
Regardless of the type of statements a seller has, buyers will scrutinize sellers’ inventory accounting policies, procedures, and methods. In this regard, we have seen the following two issues most frequently:
- Reserves: Buyers disagree with sellers regarding the appropriate levels of reserves for obsolete or excess inventory.
- Costing: Buyers disagree with sellers regarding the costing methodology for labor, material, and overhead in inventory.
It is critically important to understand that buyers focus on inventory not just because they want to ensure the balance sheet is correct. They do so because downward adjustments to inventories can have a dollar-for-dollar impact on increasing the Cost of Goods Sold, and therefore a reduction in EBITDA. Given that many price negotiations in the aerospace and defense industry are tied to EBITDA, dollar adjustments in inventory can have corresponding multiple dollar impacts on price.
Have a great day everyone.
Managing Director, Aerospace