CAUTION: It can be a working capital trap.

Since I have been a shareholder for 4 years with 33% equity in a company making 2.5MM a year wholesaling women's clothes, I will talk from experience.

The key is (mainly) in four variables:

i) the expiration date of the products, ii) the liquidation price and the channel for liquidation iii) the gross margin and iv) amount of different products and the entrance of new products.

This is the worst wholesale business you can imagine:

  1. Short expiration dates
  2. Impossible to liquidate products when the expiration date is coming and you haven't sold them yet.
  3. Tiny margins.
  4. You always need to be innovating and promoting new products.

It means that there is no margin error. You sell everything fast or you are losing money and you will be tempted to reinvest cash collected in new products to keep feeding the working capital. If your supplier gives you 60 to 90 days payment options you are trapped.

So, here is the best wholesale business:

  1. Long expiration dates (if any, more than 1 year)
  2. Channel for liquidation is available and the liquidation price still covers the cost of goods.
  3. Big gross margins.
  4. Little set of products (or just one) with stable demand.

Here it is how to analyze:

  1. From the total purchases in the last 12 months, how many of them are still in the inventory?

  2. Is the company liquidating products -i mean, doing liquidation offers-? If they are doing it, through which channels? - i don't like when liquidations are done through the same channel as the regular sales-.

  3. If they are doing liquidation, how much gross margin do they are losing? Here is the key, because, imagine, if they have 20% gross margin, and they are liquidating 20% of the total purchases at a given liquidation price, be careful, because you´re probably are not making money if depending on the liquidation price (and you are in the trap).

My advice, run from wholesale businesses that:

  1. They have high variability of product. Constantly introducing new products to customers.
  2. Short expiration dates.
  3. Liquidate through special offers to the same customers they do the regular sales.
  4. Low margins.

Of course, suppliers concentration, substitute product, structure cost and minimum sales and liquidation prices and amount to breakeven and other staffs also play a key role in order to analyze the competitive position of the company, but with the four variable i mention i think you will have a good framework to analyze a wholesale deal.

Hope it helps in your commercial due diligence.