We want to run a sell-side Quality of Earnings analysis before going to market, but our inventory accounting uses historical cost estimates rather than a perpetual tracking system. How do we clean this up before buy-side auditors use it to claim our cost of goods sold is understated?

Question

Tyler Smith · Accepted Answer

Inadequate inventory tracking is an open invitation for buy-side auditors to slash your historical EBITDA. If you rely on annual physical counts and historical cost estimates, auditors will assume your gross margins are erratic or overstated. They will reconstruct your inventory historical balances using unfavorable assumptions, leading to a retroactive haircut on your valuation.

You must launch a targeted operational initiative to clean this up before any buy-side diligence begins.

- Execute a comprehensive physical inventory count immediately and reconcile it against your general ledger to establish a clean baseline.
- Transition from historical estimates to a standard costing model or a perpetual inventory tracking system.
- Document your inventory cycle-counting procedures and historical scrap rates to prove your margins are based on real-time data, not end-of-year adjustments.

Make this inventory system cleanup a high priority company Rock for your financial seat on the Accountability Chart. By running a sell-side Quality of Earnings analysis with a qualified third-party accounting firm, you can identify and correct these inventory discrepancies internally. This allows you to present a rock-solid, audited gross margin history to potential buyers, stripping them of the leverage they would otherwise use to chip away at your purchase price.