Working Capital Calculation with no AR

June 01, 2021

by a searcher from Georgetown University in Waterloo, ON, Canada

Working on a deal that collects all payments in advance for services and therefore has no AR. They mark these deposits in their Payables as Unearned Revenue until the services are rendered.

I've pasted the Current section of the Bal Sheet below. Question is: How do I calculate Working Capital when they have no Receivables?

Current Balance Sheet
CURRENT ASSETS
Cash: $1,051
Deposits: $15

CURRENT LIABILITIES
AP & Accrued Liabilities: $1046
Income Taxes Payable: $82

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Reply by an intermediary
from Boise State University in 800 W Main St, Boise, ID 83702, USA

Hi Yas, I agree with the other two comments and have these further thoughts. Using the figures posted here by you, the company is showing negative working capital of ($62). The company likely needs continued new deposits from new customers to maintain operations. And like Timothy said, the prepaid deposits are liabilities and IF the company spent the earlier deposits to deliver goods to prior customers and not necessarily the one for which the deposit was taken, things could spiral out of control if the deposits stop flowing in (or slow down). Also, the company is likely showing a positive accrual profit but in reality has insufficient cash flow to cover operations.. This may be similar to the game of musical chairs and when the music stops, there is one less chair and not everyone gets a seat. As long as the company is growing, and the company "rides" the trade (meaning stretching the payables as much as they can get away with), they may be able to cover a good portion of the financing gap. I'm curious, how current are the payables? How long over 30 days? What kind of line of credit/bank financing does the company have? I'm betting that they are using some amount outside debt to fund their working capital cycle given that there is negative working capital. You may need to see if their banker will approve you to take over their credit line too.

Reply by an intermediary
from The University of Chicago in Chicago, IL, USA

I have sold many similar businesses. I have written a book on this subject in 2007 but not published. Have taught the subject for 10+ years. Recently, there was a $40 M EV transaction that had fallen apart after 12 months of DD on one point; and that was Working Capital (PwC was on one side and a reputed CPA firm on the other side). I was engaged to bring the parties together. The transaction closed after one week.

The key points I make are 1) accounting definition of WC and M&A definition of WC are different, and 2) literal interpretation of DFCF definition subjects the buyer at significant risk. (I have seen many buyers guided by top CPA firms on this subject gone bankrupt in 6 months after the acquisition.)

I don't have enough details on your deal. For starter, as Tim Clark said, consider Unearned Revenue as debt, but keep in mind you have to assume such debt-type liability. Happy to help. Feel free to DM me.

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