Do Your Due Diligence

Jim Newsletter The most common calls I get are usually related to new managers or major Obsolescence issues, but every so often I am asked to review the inventory of a prospective buy-sell dealership. I have to admit that I have helped numerous clients disguise their Obsolescence as the Seller to maximize their asset recovery, and some of those Buyers are now clients who want to avoid getting caught again.

What should I be buying?

Trust me; the Balance Sheet is never a true indication of what the parts inventory is worth; not even close! You can’t ever be sure if the General Ledger (GL) value has any relation to the actual inventory. Even in a normal store the Reconciliation between the DMS and GL inventories is often not done accurately, and when it becomes time to consider selling the deal it is also time to beef up the assets. Here’s what you should be looking at:

  1. Start with the DMS Parts Management Reports. That’s right, I said reports; 6 months worth of them. If someone’s been playing around with the inventory it was probably in the last 6 months. You are looking for major changes in Stocking Value, reductions in Aged Parts without a corresponding return history, dramatic increases in Lost Sales, or sudden reductions in Non Stock and Auto Phase-Out parts. All these are signs of manipulation.

  1. Look at the trending of Aged Parts, both by Months No Sale (MNS) as well as Months No Receipt (MNR.) Sudden improvements without corresponding returns are a red flag.

  1. If you’re looking at an ADP store check the volume of Return Sales. Sudden increases are indicative of false sales in 1 month re-aged by returns in the next month.

  1. Use the Report Generator to find unsold Special Orders that have not yet aged out. It is generally accepted that Non Stock (NS) parts that have been in stock for more than 60 days without a sale are probably destined to become Obsolescence; they just haven’t been around long enough to stick out yet.

  1. If you are buying a GM or Chrysler deal make sure you get a list of the RIM or ARO guaranteed parts. You’ll have to wait a while to get your money back, but at least you know you’ll have relief from the manufacturers.

  1. Specify in your pre-sale agreement that you will only purchase new OE parts that are in their original packaging and are in returnable condition. Used and take-off parts should never be bought.

  1. Clarify that you are only interested in purchasing Stocking parts that are 9 MNS or less, with the exception of manufacturer guaranteed parts. When it comes to NS parts I recommend nothing more than 2 MNS and 2 MNR since they are typically not guaranteed and have not qualified to be in inventory yet.

What should my Due Diligence Process look like?

Like most things in our business timing is everything. The longer you wait to do your Due Diligence the more time the seller has to make the inventory “fit” your requirements. I like to get into a Seller within weeks after the initial agreement has been signed.

  1. At that time I ask for a copy of the last Physical Inventory and the past 6 months of Management Reports. If they don’t have them ask them to produce them. If they won’t then there may be a problem already; be cautious from here on in.

  1. Next I get written permission to run some reports in their Report Generator. I’m looking to verify the NS Aging for Special Orders as well as how old the rest of the inventory is; not just 12 MNS but beyond that as well as MNR. I’ve found parts that are decades old in some cases and we may have to negotiate a discounted purchase for them.

  1. Run the DMS report that identifies parts that are not recognized by the manufacturers’ parts price master. You probably don’t want any of these.

  1. Do a Random Physical Inventory, counting about 5% of the bins alternating between High Volume, High Value, and High Density bins. This should give you a fair impression of how accurate the DMS inventory is.

  1. Communicate to the Buyer the recommended purchase value and why.

  1. This next step is optional, but I have found it to be very effective. In a meeting with the Seller clearly communicate what you will not be purchasing. By doing it now rather than later you give them time to dispose of some, or maybe even most of the junk, thereby avoiding a confrontation at the closing.

  1. Finally, at the closing be sure that an Inventory Management Report is included in the closing documents to verify that the value is close to what you expect from the earlier review. If it isn’t then be prepared to negotiate a reduced price for those parts that do not meet your purchase criteria.

This may sound like a lot of work, but in a recent small store buy-sell I was able to save my client almost $40,000 in parts blue sky, which is what this really is. Not bad for a few days work, right?

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