Journal of
Corporate
Renewal
April
2017
asset class and/or industry subsector.
Often, these indicators can point to
serious developing financial trends
that can lead to a liquidity crisis that
would leave little time to intervene.
While these inventory KPIs are most
often associated with, and most familiar
in, retail or consumer transactions, the
same concepts can be applied to almost
any situation involving inventory assets.
Generally speaking, when it comes to
inventory, time is often not one’s friend,
and if the necessary expertise does
not exist in-house, a lender should be
sure to seek qualified input from others
more familiar with the specifics.
Often, the most critical mistake
made when lending on inventory is
assuming that having more inventory
on hand is a “good thing” that will
improve the lender’s position on the
assets or collateral. This could not be
further from the truth and can often
lead to great difficulty in recovery.
While a natural and seemingly logical
reaction is to assume that the more,
the better, the reality is that too much
inventory—an “overinventoried”
position—could signal the beginning of
many challenges to come related to the
disposition strategy, including potential
margin deterioration. Conversely, being
“underinventoried” can also negatively
impact a company’s ability to achieve
its sales plans in a situation in which
a balanced inventory is key to optimal
performance in the normal course of
business and to optimal collateral value.
To understand these issues, there
are some basic concepts that are
critically important in the disposition
of inventory, the most notable of which
include sales capacity, period volume,
and related selling expenses. In the
most basic terms, the normal period
sales volume is the baseline from which
one will determine the overall sales
capacity or multiple of normal sales
(period volume) that can be achieved
given existing inventory levels during
a defined period and under a specific
disposition strategy. During any
disposition, necessary selling expenses
will be incurred to achieve stated sales
objectives. Simply stated, if too much
inventory exists, more time will be
needed to sell the goods, a steeper
discount cadence may be required, and,
most likely, additional expenses will be
incurred to achieve the desired results.
There is a direct correlation between
the time needed to liquidate
inventory and the associated sales
expenses. In addition, and equally
important, the concern remains that
in an overinventoried position, the
bottom one-third of the inventory
on hand is likely to be “ballooning”
(i.e., increasing), hampering the
ability to replenish the top one-third
of the inventory. As such, the more
profitable (i.e., faster turning) asset is
smaller as a percentage of the whole,
leading to the inventory becoming
stale and negatively impacting the
ultimate realizable net recovery.
This speaks to what often occurs
well ahead of any financial covenant
breach. With proactive monitoring
and safeguards in place, early
continued on page 30
There are many important considerations to keep in mind when lending on inventory assets.
Chief among them is understanding
the differences between so-called
lagging versus leading indicators
when identifying and monitoring
critical key performance indicators
(KPIs) in any given transaction. In
today’s ever-changing and fast-paced
environment, these must be monitored
proactively and continuously, with
a sound infrastructure in place to
support timely decision making.
When structuring and reviewing
diligence on a company’s inventory,
one way to think about it is that lagging
indicators have more than likely led
the parties to where they are today,
while leading indicators, if monitored
closely by the lender, will provide a
first indication of trouble spots that
may lie ahead. In the case of positive
performance trends, leading indicators
may also reveal an opportunistic case
for supporting enhanced collateral
value. These leading indicators are
those to which the lender must pay
particular attention, as they often reveal
early warning signs or key indicators
that point to looming problems
well ahead of traditional financial
measures or covenants routinely
considered at credit committees.
Leading indicators are unique in each
situation and must be identified on a
case-by-case basis. They should be
studied with a critical eye and with
input from qualified decision makers,
ideally those with experience gained
through multiple credit cycles and with
direct experience regarding the specific
