Understanding Working Capital in the Sale of a Business

We’ve come across several sales transactions in the last year and the concept of Net Working Capital (NWC) is always a point of contention once the deal is closed.

A typical deal is priced on a debt-free/cash-free basis, meaning the seller retains the cash but also pays off any debt with the proceeds of the sale.  Also, it is typical for a deal to include a NWC target.  The spirit of the NWC target is for the buyer to receive a business at a purchase price that leaves adequate working capital to operate the business.  As a side note, when we represent buyers in their due diligence process, we recommend a NWC target of 2.5x operating expenses as a rule of thumb.

However, when evaluating the NWC target, consider debt-like liabilities such as deferred revenue or customer deposits.  In these cases the buyer has the obligation to deliver on a promised product or service but the seller has retained the cash.  This is one example of a consideration that needs to be analyzed with respect to NWC.  Other examples are accrued bonuses, warranty claims and accrued commissions.

The concept of NWC, which is easily understood, can be very complicated and needs to be thoughtfully analyzed during any buy/sell transactions.

If you would like more information on NWC please contact Mike Stevenson, CPA, CFF, CFE, ABV at mstevenson@claruspartners.com or 614-545-9100 ext. 112.

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