Inventory obsolescence, explained simply
Inventory is often the largest working capital item. If obsolete stock has not been written down, the balance sheet, the working capital delivered at closing and historical gross margins are all overstated.
Diligence reviews ageing and last-sale dates, physical count results, items sold below cost and the method of costing.
Inventory after an obsolescence reserve
IllustrativeAlder Creek Manufacturing, December 2025, $ millions
Diligence reduces working capital by $0.4 million and reviews whether past gross margins were overstated.
Worked example
| Alder Creek, December 2025, $ millions | Amount |
|---|---|
| Inventory per the books | 5.0 |
| Items with no sales in over 12 months | 0.6 |
| Existing obsolescence reserve | (0.1) |
| Diligence estimate of reserve needed | (0.5) |
| Additional write-down | (0.4) |
| Adjusted inventory | 4.6 |
Alder Creek Manufacturing, Inc. is a fictional company. All figures are illustrative.
Why it matters in a deal
Overvalued inventory inflates both the working capital delivered at closing and historical margins.
Red flags
- Rising DIO with flat sales
- No physical count in the last year
- A reserve that never changes
Frequently asked questions
What is inventory obsolescence in M&A?
Inventory obsolescence is the loss in value of stock that can no longer be sold at its recorded cost because it is outdated, damaged, slow-moving or surplus. Diligence tests whether recorded inventory is realistically valued.
Does a write-down affect EBITDA?
Yes. Write-downs are usually recorded in cost of goods sold. Diligence assesses the period to which they belong.
Can obsolete inventory be excluded from the peg?
Yes, if treated the same way in both the peg and the closing balance.