Monthly Archives: October 2016

Inventory Blues – Is Excess inventory Weighing you Down?

Ideally, you want to have as little inventory on hand as possible in your business. Afterall keeping a lot of inventory, ties down your money. Having to keep a large amount of inventory on hand means that your money is sitting idle and not making money for you.

Large Inventory costs also affects the value of the business. If in addition to the business, if they have to also buy a large amount of inventory, their return on investment becomes smaller and you have a smaller pool of buyer.

However, some businesses are unique and they need to keep a large inventory. For example, if your business is built on buying very old cars, restoring them, and selling them for a fat profit, you will try and buy old cars whenever they become available, restore these and then sell them for a fat profit. And you may have several years of inventory sitting with you.

However, a typical buyer who is looking for buying your business based on cash flow, will not only have to pay for the value of the business based on the cash flow, but also buy the inventory which may not generate profit for some time, but still needs the inventory to generate profits.

In such cases, one may have to come with some creative ideas.

We came across a similar situation where this Company services and sells refurbished equipment of a very specialized make that is currently not manufactured and the owner was contemplating selling his business. Based on current sales, the Company had 3-4 years of inventory in stock. One of the ideas that we suggested to them was that the they would create a supply / management agreement with the buyer where they would supply the refurbished equipment to the buyer over a period of time, and build in a profit component in it. It will be somewhat similar to seller’s note but with higher return as he is also providing some service. Otherwise the buyer would have to pay over $2 million more for inventory for a business that is generating about $500K of earnings, and would be a difficult proposition.

Inventory Blues – Under Reporting the Inventory

Business owners often report a lower inventory value to reduce the taxes.

The logic is simple – when you report lower year-end inventory value, it implies that you have consumed more raw materials, your cost of goods is higher, and your profits and hence your taxes are lower.

However, this short term gain could create a problem when you are about to sell this business. How will the inventory be valued in the Purchase Allocations? How will you convince the buyer to pay for the actual inventory value? And if they do, who is going to have to pay the taxes on the larger amount that the buyer will have to report?

Not reporting the right inventory value is not only unethical, it is just not smart business.

Don’t be a Juggler!

A common occurrence in many small businesses is that the owner makes all of the important decisions. After starting and building the business, owners are afraid to relinquish control. They do not feel that the others are capable of running the business like they can. So you are constantly juggling various tasks and making every decision.

This is what we describe in the Value Builder System as “Hub and Spoke” system. You as the owner are the Hub and everyone else is the spoke. This can also happen if you are not the owner but a manager where you are making all the decisions.

But what happens when you, the Hub, are away? Things don’t get done. And as a result you have a hard time to get away from work. You may not have taken a vacation in years.

Not only this is stressful to you, it is also very inefficient and demoralizing for your employees (or those who work under you). And more importantly, this will drag your value down value. Research by the Value-Builder team has shown that businesses following the Hub-and-Spoke model, where owners are in control of most of the decisions, sell on an average of 2.92 times their pre-tax profit. However, the businesses where the owner is not significantly involved in day to day operation and has management team and employees empowered to make decisions and running day-to day operations, sell on an average of 4.54 times the pre-tax profit.

By making your business much less dependent on you, you can increase the value of your business by 55%! Not only that, you will have happier employees and less stress for you. You can now afford to take vacation.

But how do you do this? To start with, create operating manuals for your company. Write detailed procedures for everything that needs to be done. For each job function, you have a system or operating manual describing what needs to be done. Once you have these ready, train your employees to follow the processes and systems and give them the right tools. To quote Michael Gerber in E-Myth Revisited: “Organize around business functions, not people. Build systems within each business function. Let systems run the business and people run the systems. People come and go but the systems remain constant“. How does McDonald’s delivers the same burgers and same experience across thousands of outlets – they have the system and procedures nailed down.

Making yourself as a business owner (or manager) less important and having a system in place is just one of the eight value drivers that improves the overall valuation of your company. If you are curious about what is your score on this ValueBuilder scale, take this 13 minute survey.

So long for now.

Yatin