I'm getting ready to list my small distribution company and my broker keeps emphasizing that working capital will be a major negotiation point. I understand the basic formula (current assets minus current liabilities), but I'm confused about how the inventory line actually gets treated. If I have $400k in inventory on the books but a buyer insists on a physical count and it comes in lower, does that just reduce the purchase price dollar for dollar? And what about the accounts payable tied to that inventory? Any clarity would help.
Inventory
How inventory counts change working capital math
A physical count shortfall reduces inventory, which reduces current assets, which reduces working capital. In a typical deal, the purchase price adjusts via a working capital peg. So yes, a lower count usually means a lower price, but the mechanism is the peg, not a direct line item.
I went through this last year. The buyer's count came in about 8% under our book value. We had to eat that difference in the closing adjustment. What surprised me was that the accounts payable tied to that missing inventory didn't automatically shrink. We still owed suppliers for what we'd already received.
That's exactly the kind of scenario I'm worried about. So if the count is short but the payables stay the same, my working capital takes a double hit? Once from the asset side and then again because the liability side doesn't move?
Yes and no. If the payables are already recorded, they don't change just because a count is short. The double hit is real if the missing inventory was already paid for or is still sitting in payables. But if the shortfall is because of shrinkage over time, the payable may have been settled settled long ago. You need to trace which specific inventory is missing.
Also worth noting: many purchase agreements define working capital using a normalized or target level of inventory, not just the raw count on closing day. If your business needs $400k of inventory to operate, the peg might be set at that level. A count below that creates a shortfall you have to cover.
Our lawyer pushed for a dollar-for-dollar adjustment on any inventory variance beyond a 2% cudhion. The buyer wanted a 5% cushion. We settled at 3%. That cushion matters a lot when you're talking about hundreds of thousands in inventory.
Not to complicate things, but are you counting inventory yourself before listing? A third-party count now might reveal problems beefore a buyer does. Better to know early.
I haven't done a formal third-party count yet. We do cycle counts monthly but nothing wall-to-wall. That's probably the first thing I should do.
Cycle counts can miss a lot. We found about $60k in obsolete stock dur ing a full count that never showed up in our monthly checks. The buyer's team will find it if you don't.
One more angle: if the inventory is overstated on your books, your working capital looks healthier than it is. That can inflate your asking price expectations and then blow up during diligence. A clean count protects you from that surprise.
Did your broker explain the difference between a working capital peg and a closing adjustment? Those are two separate mechanisms. The peg sets the target. The adjustmnt trues it up after closing. If you don't have both nailed down in the LOI, you're exposed.
This thread is making me realize how much I didn't know when I sold my first business. We had no inventory to speak of, so I skipped all of this. Following along.
MarlaQuinn makes a good point about the LOI. Get the peg definition in writing early. We spent tao weeks arguing over whether slow-moving stock counted as current assets. The buyer wanted to exclude anything older than 90 days. That would have cut our working capital by a third.
That 90-day exclusion is a scary thought. We have some seasonal items that sit longer than that by design. I'll need to flag those before any LOI gets signed.
Seasonal inventory is a common fight. Some buyers will accept a trailing twelve-month average to smooth it out. Others won't budge. It depends on how badly they want the deal.