Inventory Due Diligence in M&A India 2026: Ageing, NRV, Obsolescence & Deal Red Flags
Inventory due diligence in M&A India is not a stock-count exercise. For a buyer, seller or transaction team, the core question is whether reported inventory is physically supportable, correctly costed, saleable at an appropriate value, and consistent with the earnings and working-capital assumptions used in the deal. A strong review connects quantity, ageing, costing, net realisable value (NRV), cut-off and subsequent sales evidence to quality of earnings and purchase-price mechanics. It can identify slow-moving stock, unsupported standard-cost variances, work-in-progress assumptions, obsolete items and timing issues that may otherwise distort normalized EBITDA or the target working-capital level.
What inventory due diligence in M&A India should answer
The objective is to convert a balance-sheet number into transaction evidence. Management may have a well-controlled perpetual inventory system and still carry commercial risks that matter in a deal. Conversely, an ageing item is not automatically obsolete. Diligence should therefore test both accounting support and business reality.
Does the inventory quantity reconcile from the general ledger to SKU-level records, locations and physical counts?
Is inventory owned by the target, or does it include consignment stock, customer-owned material or goods held at third-party locations?
Are raw material, work-in-progress and finished-goods costs built from supportable inputs and allocation policies?
Do ageing, subsequent sales and gross-margin evidence support the carrying value and any obsolescence provision?
Are dispatch, goods-receipt and production cut-offs consistent around the transaction date?
Could identified inventory issues affect normalized earnings, target working capital, completion accounts, indemnities or other deal protections?
Current accounting framework: cost and net realisable value
For entities applying Ind AS, Ind AS 2 is the starting accounting framework. Inventories are generally measured at the lower of cost and net realisable value. Cost includes purchase costs, conversion costs and other costs incurred in bringing inventories to their present location and condition. NRV is entity-specific: broadly, the estimated selling price in the ordinary course of business less estimated completion costs and costs necessary to make the sale.
That accounting rule is important in diligence, but transaction analysis normally goes further. A statutory carrying value can be compliant while still raising commercial questions about concentration, ageing, production efficiency, demand changes or the amount of inventory a buyer needs to fund after completion. Those are transaction judgements, not automatic accounting adjustments.
Core inventory due-diligence workstreams
1. Quantity, existence and ownership
Start with a bridge from the audited or management balance sheet to the inventory sub-ledger by SKU, plant, warehouse and category. Reconcile material differences and understand the last physical verification, cycle-count frequency and unresolved count adjustments. For stock held by job workers, warehouses or other third parties, obtain location-level evidence and examine ownership terms rather than assuming possession equals ownership.
2. Ageing, slow-moving and obsolete inventory
Ageing should be analysed by SKU and economic characteristics, not only by broad raw-material or finished-goods buckets. Useful evidence includes last movement, last sale, subsequent sale quantity and price, open customer orders, expiry or shelf-life information, engineering changes and management provisioning history. A 12-month-old strategic spare may be recoverable; a three-month-old discontinued finished good may not be. The diligence conclusion should explain the commercial evidence behind the adjustment.
3. Costing, absorption and production variances
Where standard costing or absorption costing is used, review how standards are set, how frequently they are refreshed, which overheads are absorbed and how variances are treated. Persistent favourable or adverse variances can indicate stale standards, under-absorption, capitalization of costs that should be expensed, or production inefficiencies. In transaction analysis, these findings may also inform normalized gross margin and EBITDA.
4. NRV and provisioning evidence
Test the provision methodology against actual SKU economics. Compare carrying cost with recent and subsequent selling prices, expected completion expenditure, selling costs, contractual prices where relevant and inventory-specific demand information. Ind AS 2 notes that NRV estimates should use the most reliable evidence available and are generally assessed item by item, although grouping similar or related items may be appropriate in some circumstances.
5. Cut-off, goods in transit and work in progress
Inventory diligence should connect dispatch records, goods-receipt notes, invoices, shipping terms and production records around period-end and the transaction reference date. Work in progress deserves particular attention where percentage completion or labour/overhead absorption is judgemental. A cut-off issue can simultaneously affect inventory, revenue, cost of goods sold, receivables or payables, so it should not be reviewed in isolation.
Illustrative transaction example
Assume an acquisition target reports inventory of ₹48 crore: ₹18 crore raw materials, ₹12 crore work in progress and ₹18 crore finished goods. This example is illustrative and does not represent a valuation or recommendation.
₹2.2 crore of finished goods have had no movement for more than 12 months. Subsequent sales and current orders support estimated recovery of only ₹0.8 crore. The diligence team therefore identifies a potential ₹1.4 crore value shortfall for transaction discussion.
₹0.9 crore of manufacturing variances has repeatedly been capitalized into inventory, but management cannot demonstrate that the amount reflects costs required to bring inventory to its present condition. The accounting treatment and EBITDA effect require further analysis.
₹1.1 crore of goods were invoiced near period-end but remained in the warehouse. Contract and dispatch terms are reviewed to determine whether revenue, receivables and inventory were recorded in the correct period.
The transaction team should not simply add these figures and deduct them from enterprise value. Each finding must be classified. One item may require an accounting correction, another may be a quality-of-earnings adjustment, another may alter normalized working capital, and another may be addressed through completion accounts, warranties, indemnities or pre-closing remediation. Double counting is a major transaction risk.
How inventory findings connect to price and deal mechanics
Inventory sits at the intersection of earnings and working capital. An overstated closing stock balance can improve reported gross profit; an obsolete-stock provision can affect EBITDA; excess inventory may inflate the working-capital peg; and supplier or cut-off issues can move both inventory and payables. The analysis should therefore be reconciled to the wider financial due-diligence model.
For the broader transaction framework, see PGT & Associates’ Quality of Earnings in Financial Due Diligence India, Working Capital Normalization in M&A India and Revenue Quality in Financial Due Diligence India.
Common inventory red flags in financial due diligence
Material inventory ageing with little evidence of subsequent movement or sale.
Large manual journals to inventory or cost of goods sold around month-end or year-end.
Frequent physical-count differences that remain unexplained or are cleared through broad adjustments.
Standard costs not refreshed despite significant commodity, labour or overhead changes.
Obsolescence provisions based only on a fixed ageing percentage without SKU-level commercial evidence.
Negative inventory balances, unusual quantities in transit or unresolved warehouse-to-ledger differences.
Sharp improvement in gross margin accompanied by rising inventory days or weak cash conversion.
Customer-specific, customized or discontinued inventory without firm orders or recovery support.
Work-in-progress percentages that depend heavily on management estimates and lack production evidence.
The same inventory issue being reflected in both EBITDA and working-capital adjustments without a clear anti-double-counting bridge.
10-point inventory due-diligence checklist for transaction teams
Reconcile the inventory general ledger to the SKU and location-level sub-ledger for each diligence period.
Obtain physical-count reports, cycle-count adjustments and explanations for material variances.
Map inventory ownership, consignment arrangements, goods with third parties and goods in transit.
Analyse ageing and last movement by SKU, category, plant and customer-specific status.
Test subsequent sales, selling prices, open orders and demand evidence for material aged items.
Review costing methodology, bills of material, labour and overhead absorption, standard-cost updates and production variances.
Reperform selected NRV and obsolescence calculations using item-level evidence.
Test purchase, production, dispatch and sales cut-off around reporting and transaction dates.
Bridge inventory findings to gross margin, normalized EBITDA, normalized working capital and cash conversion.
Maintain a finding-by-finding deal bridge showing whether each issue is accounting, EBITDA, working capital, debt-like, indemnity, covenant or remediation related.
FAQs
Is inventory ageing alone enough to calculate an M&A adjustment?
No. Ageing is a screening tool. A supportable conclusion should consider subsequent sales, demand, contractual orders, shelf life, technological changes, recoverable selling prices, completion and selling costs, and the purpose for which inventory is held.
Does an obsolete-inventory finding always reduce purchase price?
Not automatically. Its treatment depends on the transaction structure and whether the matter is already reflected in reported earnings, the working-capital target, completion accounts or other agreed mechanisms. The key is consistent classification and avoiding double counting.
Why does inventory due diligence matter for quality of earnings?
Because closing inventory affects cost of goods sold and therefore gross profit. Costing errors, unsupported capitalization or changes in provisions can distort historical margins and make reported EBITDA less representative of sustainable earnings.
What evidence is most useful for NRV testing?
Useful evidence commonly includes SKU-level cost, current price lists, recent and subsequent sales, firm orders, completion costs, selling costs, ageing, returns, expiry data, product discontinuation information and management’s historical provisioning accuracy.
Is inventory due diligence the same as a stock audit?
No. A stock audit or physical verification may be an important evidence source, but transaction diligence has a broader objective: understanding the effect of inventory quality on earnings, cash conversion, working capital, transaction pricing and deal protections.
Practical takeaway
For transaction teams, the highest-value inventory work is not a generic stock statement. It is a traceable bridge from SKU-level evidence to accounting quality and then to deal economics. The review should make clear what is fact, what is management estimate, what is an accounting requirement and what is professional transaction judgement.
PGT & Associates can support buyers, sellers, promoters and finance teams with financial due diligence, quality-of-earnings analysis, inventory and working-capital review, and transaction data-room preparation. The scope and conclusions depend on the facts, records and transaction terms; no transaction, valuation or financing outcome is guaranteed.
Framework references
Accounting framework references used for this guide include the Ministry of Corporate Affairs’ Ind AS 2 — Inventories and ICAI’s Educational Material on Ind AS 2. Transaction examples and deal classifications above are illustrative professional analysis, not statutory rules.
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