Working capital is one of those financial concepts that most business owners understand intuitively but rarely think about in formal terms, until they start discussing the sale of their business. Then, suddenly, it becomes one of the most important numbers in the transaction. Working capital adjustments are a standard feature of business acquisitions, and they are also one of the most common sources of confusion and disagreement between buyers and sellers.

If you are a business owner considering a sale, understanding how working capital works in the context of an acquisition will help you negotiate more effectively, avoid surprises at closing, and ultimately feel more confident about the deal structure.

What Is Working Capital?

In its simplest form, working capital is the difference between a company's current assets and its current liabilities. Current assets typically include cash, accounts receivable, inventory, and prepaid expenses. Current liabilities include accounts payable, accrued expenses, short-term debt, and other obligations due within the next twelve months.

Working Capital = Current Assets - Current Liabilities

Working capital represents the operating liquidity of the business, the fuel that keeps daily operations running. It is the money available to pay suppliers, cover payroll, fund inventory purchases, and manage the normal ebb and flow of cash in any operating company.

For a distribution company in the Puget Sound area, for example, working capital might include the inventory sitting in a warehouse in Kent, the receivables from customers in Seattle and Bellevue, and the payables owed to suppliers. The interplay of these items determines whether the business has enough liquidity to operate smoothly on any given day.

Why Working Capital Matters in Acquisitions

When a buyer acquires a business, they are buying it as a going concern, meaning they expect it to continue operating without interruption. For that to happen, the business needs a sufficient level of working capital at the time of closing. If the seller were to drain the bank accounts, collect all receivables, and delay paying suppliers before the sale, the buyer would inherit a business without the liquidity to function.

This is why virtually every business acquisition agreement includes a working capital provision. The provision establishes an agreed-upon target level of working capital that the seller is expected to deliver at closing. If the actual working capital at closing is above the target, the seller typically receives the excess. If it is below the target, the purchase price is reduced accordingly.

Think of it this way: the purchase price assumes a "normal" level of working capital will be included in the sale. The working capital mechanism ensures that this actually happens.

How the Target Is Set

The working capital target, sometimes called the "peg," is usually based on the historical average of the business's working capital over a defined period, typically the trailing twelve months or the trailing twenty-four months. The idea is to establish what a "normal" level of working capital looks like for the business based on its actual operating history.

Calculating the target requires careful analysis. Seasonal businesses, for example, may have significant fluctuations in working capital throughout the year. A landscaping company in the Seattle area might have high receivables and low payables in the summer, with the reverse in winter. Using a simple average without accounting for seasonality could produce a target that does not reflect normal conditions at any given point in the year.

Buyers and sellers may also negotiate which specific line items are included in the working capital calculation. Cash and debt are frequently excluded, as they are typically handled separately in the deal structure. Certain prepaid expenses, deferred revenue, or unusual receivables may also be subject to negotiation. Getting alignment on the definition and the calculation methodology early in the process is essential to avoiding disputes later.

How Adjustments Work at Closing

In a typical transaction, the working capital adjustment process works in two stages:

  1. Estimated closing adjustment. At closing, the seller provides an estimated working capital figure based on the most recent available data. The purchase price is adjusted up or down based on how this estimate compares to the target.
  2. Post-closing true-up. Within 60 to 90 days after closing, the buyer prepares a final working capital calculation based on the actual books as of the closing date. If the final number differs from the estimate, a "true-up" payment is made, either the buyer pays the seller or the seller refunds the buyer, depending on the direction of the difference.

This two-stage process exists because it is often impossible to know the exact working capital figure on the day of closing. Invoices arrive, payments clear, and accruals are finalized over time. The true-up mechanism ensures that the final economics of the deal reflect reality rather than estimates.

Common Disputes and How to Avoid Them

Working capital disputes are among the most common post-closing disagreements in business acquisitions. They typically arise from a few predictable sources.

  • Disagreements over what is included. If the definition of working capital is not clearly specified in the purchase agreement, the buyer and seller may disagree about which line items belong in the calculation. Ambiguity in the definition is the leading cause of working capital disputes.
  • Inconsistent accounting methods. If the buyer uses different accounting methods or policies to calculate the final working capital than the seller used historically, the results can differ significantly. The purchase agreement should specify that the post-closing calculation will use the same accounting methods and policies that were used historically.
  • Manipulation before closing. Sometimes sellers, whether intentionally or not, alter their normal operating patterns in the months leading up to closing. Aggressively collecting receivables, delaying payables, or drawing down inventory can all inflate working capital temporarily. Buyers are aware of this possibility and will scrutinize any departures from historical norms.
  • Seasonal timing issues. If the closing date falls at a point in the year when working capital is naturally higher or lower than the target, the adjustment can feel unfair to one side. This is why the choice of averaging period and the timing of the closing both matter.

The best way to avoid disputes is to have a clearly written working capital provision in the purchase agreement, with an explicit definition, a well-supported target, and agreed-upon accounting policies. Working with experienced advisors, both legal and financial, is strongly recommended.

Tips for Sellers: Normalizing Working Capital Before a Sale

If you are planning to sell your business in the next year or two, there are steps you can take now to ensure the working capital discussion goes smoothly.

  • Maintain normal operating patterns. Resist the temptation to aggressively manage working capital in the months before a sale. Buyers will notice, and it will erode trust.
  • Clean up your balance sheet. Write off any uncollectible receivables, dispose of obsolete inventory, and reconcile any old or disputed payables. A clean balance sheet produces a cleaner working capital calculation.
  • Understand your own numbers. Many business owners cannot recite their working capital figure off the top of their head, and that is fine. But before entering a transaction, you should understand what your normal working capital looks like, how it fluctuates seasonally, and what drives changes from month to month.
  • Work with your CPA. Ask your accountant to help you calculate trailing working capital and identify any items that might be unusual or require explanation. Being prepared to walk a buyer through your working capital history is a significant advantage.
  • Think about timing. If your business has strong seasonal patterns, consider how the timing of a potential closing might affect the working capital adjustment. Closing at a point in the year when working capital is near its historical average can simplify the process for both sides.

Working Capital Is Part of the Bigger Picture

Working capital adjustments can feel technical and abstract, but they serve a practical purpose. They ensure that the buyer receives a business with the liquidity it needs to operate, and they ensure that the seller is fairly compensated for the assets they deliver. When both sides understand the mechanics and approach the discussion in good faith, working capital rarely becomes a significant obstacle.

At Hawkfall Holdings, we are transparent about how we approach working capital in our acquisitions. We believe that clear communication about financial mechanics builds trust and leads to better outcomes for both parties. If you are a business owner in Seattle or the Pacific Northwest and you have questions about how working capital might affect the sale of your business, we are happy to walk you through the process. Visit our Sell Your Business page or get in touch for a confidential conversation.