The working capital is one of the most scrutinized metrics by the buy side, and the details surrounding it influence how much money the seller walks away with. Hence, it is important for the seller to further understand how working capital adjustment business sale works in M&A deals.
What Is Working Capital and Why Buyers Care About It
Buyers pay close attention to working capital because it reflects the everyday liquidity and financial status of the acquisition target. There are two common scenarios:
If there’s too little, they may need to inject additional cash after closing.
If there’s too much, they might feel they’re overpaying.
That’s why working capital analyses, pegs, and adjustments have become core parts of due diligence and deal structuring. When sellers know how this is set and reconciled, they can evade post-deal disputes with the buyer and secure a price that matches the negotiated value.
The Working Capital Peg: Setting the Target
In any M&A transaction, both sides need objective alignment on the day-to-day operating cash flow of the target company. The benchmark that both sides arrive at is known as the working capital peg. This is the level of working capital that should be available at the deal’s close. It gives the acquirer the assurance that there are enough funds to keep the company running without them having to shell out money. When established accurately, a working capital dispute business sale is prevented.
Most deal teams evaluate historical values and use averages from the prior twelve months of working capital to get the balanced value. This baseline should then be normalized during due diligence in consideration of seasonal fluctuations, non-recurring events, and other irregular items. The point of this adjustment is to determine a normalized working capital business level that uses the company’s typical financial rhythm as the basis.
The closing adjustments can be made upon determining the working capital peg M&A target. Does the actual working capital at completion fall below the peg? The buyer will then pay less. Does it exceed the peg? Then the seller takes home more money.
Cash-Free, Debt-Free Transactions Explained
Cash-free, debt-free transactions are typical in M&A. They set up normalized business valuations due to the condition they require: at closing, the business is without any cash or debt on its balance sheet.
What happens in this setup?
The seller retains all excess cash generated before the sale and remains responsible for paying off any outstanding borrowings or financing obligations.
The buyer acquires the operational business itself.
When the company is acquired in this manner, only the worth of its operations, free of financing decisions or temporary cash positions, is considered. In other words, its enterprise value. The acquirer will only account for the performance and sustainability of the core operations in the due diligence evaluations.
In a cash free debt free working capital context, the buyer expects the business to come with a normalized amount of working capital. Basically, the company should have enough cash, inventory, and customer payments coming in to keep the business running smoothly right after the sale, without needing extra funds.
If the business’s working capital at closing is different from the agreed “target” amount, the final sale price is adjusted. For instance, if the business has less working capital than expected, the buyer pays less to cover the shortfall. But if it has more than the target, the seller gets a higher price to reflect that extra value.
What Is Typically Included and Excluded
What counts as working capital in M&A is current assets and current liabilities, which are all found on the balance sheet. Every company is different, so some items listed below may not be applicable. The best example is the absence of inventory in a service-focused business.
Firstly, the following current assets are included:
The company’s money on-hand and various kinds of investments.
Inventory
Unsold products
Raw materials
WIPs
Accounts receivable. Money owed by customers via credit sales, minus any bad debt cushion.
Notes receivable. Money due from other contracts or deals, typically backed by a signed agreement.
Deferred charges. The amount for costs paid upfront, which may not easily turn into cash but still hold value short-term-wise.
Other short-term assets.
The company’s current liabilities are also part of the computation:
Accounts payable. Money owed to suppliers for all business costs. Most come with payment terms like net 30 days, covering the bulk of outstanding invoices.
Wages payable. Salaries and wages still owed to employees.
Current portion of long-term debt. Debt payments approaching their term. Working capital-wise, only consider the next 12 months’ portion.
Accrued tax payable. Taxes payable to the government, including those in the upcoming year.
Dividend payable. Payouts for distribution to shareholders. The company can skip future ones, but must pay out the ones that are approved.
Unearned revenue. Money received upfront before finishing the job. If the work isn’t completed, that cash might need to go back to the customer.
How the True-Up Adjustment Works at Closing
A true-up adjustment is the method of bridging the gap between the agreed working capital peg and the estimated working capital determined just before closing through an increase or decrease in the purchase price.
When the transaction is nearing its end, the seller prepares a good‑faith estimate of the company’s working capital using the closing date as a reference, excluding cash and interest‑bearing debt (the estimated working capital). Consistency with the working capital peg can be achieved by using the same definitions and methodologies.
The estimated working capital is then compared against the working capital peg.
If estimated working capital is higher than the peg, the excess increases the dollar-for-dollar purchase price due to the buyer getting more working capital than assumed earlier.
If the estimated working capital is below the agreed level, the gap must be covered, either by the seller adding cash at closing or by lowering the purchase price by that amount.
Look up “working capital true-up business sale” or “working capital adjustment closing,” and you’ll learn that there are instances wherein an after-deal true‑up once the final closing balance sheet is prepared, which replaces the estimate with actual numbers and triggers a final payment from the buyer or a refund from the seller if the estimate was off relative to the working capital peg.
Common Working Capital Disputes Between Buyers and Sellers
Vague definitions and misaligned expectations are the common roots of many post-closing working capital disagreements. Listed below the most common issues.
If the seller’s historical accounting is informal, undocumented, or has evolved over time, each side can reasonably argue for a different “consistent” approach once the true-up starts.
The working capital pegs themselves can be a problem if they fail to represent the actual operating requirements. Parties often base the peg on trailing 12‑month averages, but without consideration for unusual events and pre-closing changes, the true-up effectively reopens the purchase price instead of serving as a neutral adjustment.
Issues also flare up around the mechanics of resolving working capital disputes.
Deal fatigue near the signing and closing stages creates another common flash point. The parties often leave key working capital definitions vague, assume there is a shared “business understanding,” or postpone thorny accounting issues to be sorted out later. Those late-stage compromises rarely stop a deal from closing, but they frequently resurface as contentious and costly post-closing adjustment disputes.
Industry-Specific Working Capital Norms
Working capital norms are often expressed through working capital intensity (a metric that shows how much net working capital is needed to generate one dollar of revenue). Let’s take a look at
Software/SaaS. Working capital intensity is negative or very low because there is no physical inventory and high deferred revenue from upfront subscriptions, often resulting in negative NWC.
Retail/FMCG. Intensity is low to negative due to high inventory turnover, where customers pay cash immediately, while suppliers are paid much later.
Manufacturing. This sector has moderate to high intensity because of significant raw materials, work-in-progress (WIP), and finished goods necessitated by longer production cycles.
Infrastructure/Construction. Working capital intensity is very high due to long project timelines and high accounts receivable from milestone-based billing, leading to characteristic high NWC intensity.
How to Negotiate a Favorable Peg Before Signing
Start by reviewing your actual monthly working capital over the last 12 months from the most recent month-end. Since most deals are cash-free and debt-free, leave out cash and any interest-bearing debt from the calculation.
If you’re selling, adjust the historical balance sheet numbers to match what the buyer will likely see after closing, tying them to normalized income statement figures. For instance, exclude one-time stretched customer payment terms if those won’t continue for the buyer.
Watch for overdue supplier bills—buyers might treat them like debt you have to cover at closing, cutting your take-home cash. Push back by getting vendors to commit to those longer terms permanently.
Note that customer deposits for future jobs usually stay in the business as an exception to the cash-free rule. To lessen the hit, spot work already done but not billed, recognize it, and lower the deposit balance.
For software or subscription companies, begin by removing deferred revenue from the analysis. A good middle ground is to include the estimated future costs needed to deliver on those commitments.
Three timing factors can shift the numbers: the lookback period for setting the target, how many days of old customer invoices the buyer won’t count, and how many days of supplier bills they’ll flag as debt-like. Compare your figures to your past averages and industry standards to argue for carve-outs that lower the target peg.
Preparing Your Balance Sheet to Minimize Surprises
A clean balance sheet prior to the sale prepares you for due diligence and lessens pre- and post-closing claims from the acquirer regarding working capital. Protect your purchase price using these issue-minimizing practices.
Keep your balance‑sheet accounts reconciled and up to date. Avoid discrepancies or having to hide items due to mismatched bank statements, subsidiary ledgers, and general‑ledger balances. Buyers often restate working capital using the accrual basis, so having clean, current balances makes that restatement smoother and less likely to yield negative surprises.
Make sure accounts receivable are truly collectible and write off any amounts that are unlikely to be collected. Overstated receivables inflate working capital and can trigger downward adjustments after closing.
Conduct accurate physical inventory counts and book inventory at the correct net value, including reserves for obsolete or slow‑moving stock. If inventory is overstated, a post‑close shortage can lead to lost sales and escrow claims that reduce the seller’s net proceeds.
Review accrual policies closely and correct improper accruals or missing reserves. For example, unpaid vacation or bonuses that should be accrued as liabilities must appear on the balance sheet, or buyers will add them back during their working‑capital analysis.
Deferred revenue and customer deposits should be treated as liabilities, not revenue, until the service or product is delivered. Prepaying customers’ money should be tagged as deferred revenue or a deposit instead of earned income. Because when you sell a business, the buyer may recategorize those amounts, otherwise.
FAQs: Working Capital Adjustments in Business Sales
Why do we do a working capital adjustment?
A working capital adjustment to make sure the buyer receives a business with a normal level of operating liquidity at closing and to prevent either side from being unfairly helped or hurt by short‑term balance sheet swings.
How to calculate working capital when selling a business?
This is how working capital is calculated M&A:
NWC = Current Assets (not including cash) – Current Liabilities (not including debt)
Where:
Current assets:
Accounts receivable
Inventory
Expenses paid in advance expected to be realized as cash within one year
Current liabilities:
Accounts payable
Accrued expenses
Trade debt to be settled soon
Key Takeaways
A buyer pays close attention to the business’s working capital since it reflects how efficiently short‑term resources are managed and determines the additional funds required to sustain operations once ownership changes hands.
The working capital peg is the benchmark both sides use to define the level of working capital that should be in the business at closing, so the buyer can operate it without injecting extra funds.
Setting the peg starts with historical monthly working capital and then normalizing it for seasonality, non‑recurring events, and irregular items to reflect the company’s typical financial rhythm.
Working capital in M&A usually includes current assets and current liabilities on the balance sheet, but what is included or excluded depends on the business model and must be clearly defined.
A true-up is a post-closing confirmation that compares the actual vs. the working capital peg.
Many post‑closing disputes come from vague working capital definitions, pegs that don’t match real operating needs, and deal fatigue that pushes hard accounting questions to “later.”
Industry norms for working capital intensity vary widely, so software, retail, manufacturing, and construction businesses each have different “typical” levels that should inform the peg.
FAQs
How is net working capital business acquisition calculated when you sell your company?
Net working capital in the context of M&A the company’s current assets (cash excluded) and minus its current liabilities (interest-incurring debt excluded) as of the agreed measurement date by the buy side and sell side.
What are some effective negotiating strategies for setting a working capital target purchase agreement?
At the early stage of the deal (as early as receiving the LOI) settle the formulas with the acquirer. This includes caps to limit adjustments. A business broker will also advise you to limit the review to within 6 to 12 months of the latest data, and match accounting principles of past with present records, as these practices help achieve fairness.
