Working capital calculations

November 28, 2024

by a searcher from University of California, Santa Barbara in Toronto, ON, Canada

What's a good source that teaches the working capital calculations? What is the right amount that I should insist be in the company on day 1?

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Reply by an intermediary
from St. Vincent College in Pittsburgh, PA, USA

Lots of great insight in this thread. Working capital is one of the most challenging aspects of a deal. From a purely philosophical perspective, there is a huge hurdle for most seller's to overcome as they see the AR as money they earned and where inventory is in play that those are their goods. At a minimum, seller's want to get paid for those assets if they don't get to retain them. Meanwhile, a buyer is expecting to get a turnkey business and needs that AR and inventory for the business to operate as it has historically done so, and most, but not all, multiples assume the inclusion of working capital as an asset to be conveyed to the buyer regardless of whether or not it is a stock or asset purchase (per se on normalized level with amounts above or below impacting the purchase price on a dollar-for-dollar adjustment). Another factor to consider is how the working capital is calculated. Book/accounting working capital definition is different than in the M&A world. To continue to add to the difficulties is that two businesses in the exact same space can have significantly different working capital structures due to payor mix (i.e., days sales outstanding), inventory methods, payroll process, vacation policy, AP policies, etc. I could make the argument that even historical, normalized working capital may not be the right working capital target. For instance, there are many entrepreneurs that are "debt adverse" and pay any bill within a couple days that it is received rather than use the normal payment terms to their advantage thereby inflating working capital. There are many other instances where working capital as it is represented historically may not be a great representation as it should be "pegged" for the transaction.

Reply by a professional
from James Madison University in Washington, DC, USA

thanks for the tag ^redacted‌ ^redacted‌ many have shared great insights.
Having completed over 150 SMB deals, I’ve learned there’s no single "correct" amount for net working capital (NWC).

The best approach is to partner with someone who can thoroughly assess the NWC and facilitate discussions between you (the buyer), the seller, and the management team. This ensures a fair and equitable solution for all parties. The purpose of working capital is to provide the buyer with sufficient funds to maintain normal business operations post-acquisition and avoid the need for a "capital call." Capital calls, particularly in the early days of new ownership, can create substantial financial risks for the buyer. I hope this helps!

Feel free to DM me if you'd like to learn more.

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