Slow-Moving Stock: a Worked Example

Stock is worth to a lender what it will turn into, and when. Most of a distributor's range sells within weeks and comes back as debtors and then cash. A smaller part sits: superseded models, an over-ordered line, spare parts for a machine that has gone out of use, a season that did not sell through. That part is the weakest promise of cash on the balance sheet. It is the first to be discounted if the business has to sell in a hurry, and in a forced sale a buyer may not want it at all.

The total stock figure hides that split. A business can hold steady stock while the share of it that is not moving doubles, if the turning lines are being run down to fund the stuck ones. A lender therefore asks for an ageing of the stock as well as its value.

No accounting standard defines slow-moving. Businesses and lenders set their own test, usually the time since a line last sold or the stock held against recent sales, such as more than a year's supply. The useful measure is the last sale, not the last movement: a transfer between warehouses or a stocktake adjustment can reset a movement date without a customer ever having paid for the goods. A facility agreement that defines eligible stock usually says which measure it uses.

Valuation is where the accounts come in. IAS 2 and its New Zealand and Australian equivalents carry stock at the lower of cost and net realisable value, the estimated selling price less the costs to complete and sell. FRS 102, used by most UK mid-market companies, applies the same test in its own words. Slow sales are not themselves a reason to write stock down; a write-down is needed when the expected selling price has fallen below cost. Estimating that is a judgement, and owner-managed businesses, and smaller borrowers whose accounts are not prepared to these standards, may make it late or not at all.

An automotive parts wholesaler, constructed for this page like every figure in it, holds stock of US$9.6m at cost against cost of sales of US$32m a year, and carries a stock provision of US$0.2m. Its stock ageing, by last sale date, and its lender's borrowing base rules, which belong to the example and are not a market norm, read as follows. In US$ millions:

The age test takes US$0.82m off what the stock would support at a flat rate. The lender then forms its own view of value. If the 6–12 month lines would sell at about 80% of cost and the older lines at about 40%, the shortfall below cost is larger than the provision held:

The business reports 110 days of stock. The part that sells turns in about 82. The other 27 or so days' worth, US$2.4m, is the tail, and it is where the US$0.64m of earnings and equity the accounts may not yet show is sitting. A year earlier the two slow bands held US$1.1m, so the tail has more than doubled while the headline total barely moved.

Obsolete stock has no market at a normal price through normal channels: a discontinued part, expired goods, packaging for a product that no longer exists. Slow-moving stock still has buyers, only fewer of them and later. The distinction matters because the reading differs. Obsolete stock is usually written down to scrap or clearance value and excluded outright. Slow-moving stock may be worth its cost, and some of it is held deliberately: critical spares a customer relies on, a seasonal range bought ahead, or a supplier's minimum order. A lender asks which is which before it applies a blanket rule.

Slow stock is also the place to read inventory days properly, since the average blends lines that turn with lines that do not, and the forced-sale value a valuer gives the stock will usually fall furthest on the slow and obsolete bands.

DEFINED IN ONE PARAGRAPH → · BORROWING BASE → · TEMPORARY OR PERMANENT WORKING CAPITAL →

It decides the size of a stock-backed facility, through the age bands and advance rates written into the eligibility definition, and it decides each borrowing base certificate after that. It decides the stock audit, where the lender tests the ageing against sales records and looks for lines whose movement dates were reset by transfers. And it decides the conversation about earnings: a provision that has not kept pace with a growing tail is a write-down postponed, and the lender would rather hear about it before the year-end than from the auditor.

Clearing slow stock below cost turns a weak asset into cash at the price of a loss. A lender usually prefers that to a tail that keeps growing, and reads a business that has done it, and changed how it buys, as a business that has seen the problem.

HOW BANKS ASSESS A WORKING CAPITAL REQUEST → · THE CASH CONVERSION CYCLE →