I recall a conversation I had with a CEO client about the fact that his company had more inventory than it needed. He looked at me and said, “What difference does it make? I don’t own it, the bank does.” I was speechless.
When banks provide lines of credit, they primarily lend on Accounts Receivable. For companies that have inventory, the bank will often lend on a portion of that as well. The primary consideration for the bank is how easily the inventory can be turned into cash, therefore, the maximum the bank will lend on inventory is usually limited to 50% of current value. Occasionally that might be higher or lower, but 50% seems to be the number in the current market. That means the company, owner, and investors own the other 50%.
To make matters worse, before the bank calculates 50% they’ll often eliminate the old or obsolete inventory from the total value. Normally this is anything more than a year old, but it could be a longer time horizon if the inventory is easily converted to cash. But it’s fair to say that the bank owns half, and it’s the good half. The owner owns the remaining (slow moving) half.
Do you own half of your inventory? Is it the bad half? Can it easily be turned into cash? If not, your half is slowly eroding and costing you profits and cash flow every day.
© 2017 – Rick Pay – All Rights Reserved