Working Capital
Current assets minus current liabilities — the liquid resources needed to operate a business day-to-day. Working capital requirements are a critical negotiating point in business sales.
What is Working Capital?
Working capital is the difference between a company's current assets and current liabilities:
Working Capital = Current Assets − Current Liabilities
Current assets include cash, accounts receivable, and inventory. Current liabilities include accounts payable, accrued expenses, and short-term debt.
Positive working capital means a business can pay its short-term obligations. Negative working capital can signal liquidity problems.
Why Working Capital Matters in M&A
In most business sales, deals are negotiated on a cash-free, debt-free basis with normalized working capital. This means:
- The seller keeps cash and pays off debt before closing
- The buyer receives a "normal" level of working capital to operate the business
If the seller delivers more working capital than the target, the buyer pays extra. If the seller delivers less, the price is reduced.
This is called a working capital peg or working capital target.
The Working Capital Peg
Before closing, buyers and sellers agree on a target working capital amount — typically based on the trailing 12-month average.
At closing, if actual working capital:
- Exceeds the target → Buyer pays the difference (seller gets more)
- Is below the target → Purchase price is reduced (seller gets less)
Why Sellers Get Tripped Up on Working Capital
Working capital adjustments are one of the most common sources of post-closing disputes. Sellers sometimes:
- Delay paying vendor invoices to inflate cash
- Collect receivables early to boost current assets
- Misunderstand what's included in the definition
Work with your M&A attorney and accountant to negotiate the working capital definition carefully. The devil is in the details — what counts as a "current asset" or "current liability" can significantly change the final payment.
Normalized Working Capital
Buyers want normalized working capital — what the business typically needs to operate, not what happened to be on the balance sheet on closing day. Your trailing 12-month average is the usual starting point for negotiation.