Managing Working Capital
Mar 26, 2025
Key Takeaways
Working capital adjustments can impact final proceeds by 5-15% of the total deal value
Address working capital in the LOI stage, not just in the final purchase agreement
Understanding your business's working capital patterns and seasonality is critical for negotiating fair terms
Negotiate a clear calculation methodology that specifies which accounts are included and excluded
Push for a "collar" or buffer zone where small variations don't trigger adjustments
Strategically manage inventory, accounts receivable, and accounts payable 3-6 months before closing
Working with advisors experienced in working capital negotiations can pay for itself many times over
Imagine this scenario: After months of negotiation, you've agreed to sell your business for $2 million. You're mentally spending that money already—until closing day arrives, and you're handed a check for $1.7 million instead. What happened to the other $300,000? Working capital adjustments.
For many business owners, working capital is the stealth factor that can dramatically impact how much cash they actually walk away with at closing. Yet surprisingly, it's often overlooked until late in the deal process, when negotiating leverage has diminished.
This comprehensive guide will help you understand how working capital impacts your business sale, and more importantly, how to prepare for and negotiate working capital provisions to maximize your final payout.
What Is Working Capital and Why Does It Matter in Business Sales?
The Basic Definition
Working capital represents the funds needed to operate your business on a day-to-day basis, calculated as:
Working Capital = Current Assets - Current Liabilities
Key components include:
Current Assets: Cash, accounts receivable, inventory, prepaid expenses
Current Liabilities: Accounts payable, accrued expenses, short-term debt
The "Normal" Working Capital Concept
In most business sales, the purchase price is based on the assumption that the business will be transferred with a "normal" or "adequate" level of working capital—enough to continue operating without immediate cash infusions from the new owner.
This makes intuitive sense. If you've been running your business with $500,000 in working capital and suddenly drain the accounts receivable, inventory, and cash right before closing, the buyer would need to immediately invest significant funds just to keep operating. That's not what they bargained for when agreeing to your purchase price.
Why Working Capital Adjustments Exist
The working capital adjustment mechanism ensures that:
The seller can't strip the business of operating funds before closing
The buyer receives sufficient resources to operate post-closing
Seasonal or cyclical businesses are treated fairly regardless of closing date
Real-world example: Sarah sold her landscaping business, which had significant seasonality—high receivables and inventory in summer, lower in winter. The working capital adjustment ensured that when she closed in December (low season), she wasn't penalized for having lower-than-annual-average working capital at that particular time.
How Working Capital Adjustments Actually Work
Most purchase agreements include a mechanism that compares the actual working capital at closing to a predetermined target amount. Here's how it typically works:
Step 1: Establish a Target Working Capital Amount
This is usually based on a historical average, often the last 12 months of operations. For example, if your monthly working capital has averaged $300,000 over the past year, that becomes your target.
Step 2: Measure Actual Working Capital at Closing
After closing, the buyer calculates the actual working capital as of the closing date based on the closing balance sheet.
Step 3: Calculate and Pay the Adjustment
If actual > target: Seller receives the excess amount
If actual < target: Seller pays (or has escrow reduced by) the shortfall
Example calculation:
Target working capital: $300,000
Actual working capital at closing: $250,000
Adjustment due to buyer: $50,000
This adjustment is typically settled after closing, once the final closing balance sheet is prepared, often within 60-90 days.
The 5 Working Capital Mistakes That Cost Sellers Thousands
Many business owners make critical mistakes that put them at a disadvantage in working capital negotiations. Here are the most common ones to avoid:
Mistake #1: Leaving Working Capital Discussions Until the End
The problem: Deferring working capital discussions until after the LOI (Letter of Intent) stage severely limits your negotiating power.
The solution: Address working capital methodology early in negotiations, ideally in the LOI. While you may not set the specific target amount at this stage, establish how it will be calculated and what will be included.
Pro tip: Include language like "Working capital target will be based on the average monthly working capital for the trailing twelve months, excluding cash and debt" in your LOI.
Mistake #2: Not Understanding Your Working Capital Cycle
The problem: If you don't understand your own working capital patterns, you can't effectively negotiate a fair target.
The solution: Analyze your working capital for the past 24-36 months to identify:
Monthly fluctuations
Seasonal patterns
Trends (increasing or decreasing)
Anomalies that should be excluded
Real-world example: Mark's manufacturing business showed wide monthly working capital swings from $400,000 to $700,000 due to large client order cycles. By documenting this pattern, he negotiated a seasonal adjustment formula rather than a simple average, avoiding a potential $150,000 loss from closing during a high working capital month.
Mistake #3: Allowing Inappropriate Items in the Calculation
The problem: Buyers may push to include or exclude items that benefit them in working capital calculations.
The solution: Clearly define which accounts are included in working capital calculations. Generally:
Items typically included:
Accounts receivable (often with aging exclusions)
Inventory (saleable)
Prepaid expenses
Accounts payable
Accrued expenses
Items typically excluded:
Cash
Income tax assets/liabilities
Debt
Customer deposits/deferred revenue (sometimes)
Non-operating assets and liabilities
Pro tip: Push to exclude cash from working capital calculations. This allows you to keep all cash on the balance sheet at closing, which can be a significant benefit.
Mistake #4: Accepting a Target Based on Closing Month Projections
The problem: Using projected working capital for the closing month as your target can be risky, as these projections often prove inaccurate.
The solution: Base your target on historical actual results, typically a trailing 12-month average to capture seasonal variations.
Expert insight: "Historical performance is verifiable and objective. Projections are subjective and often become a point of contention during closing adjustments."
Mistake #5: Neglecting to Manage Working Capital Pre-Closing
The problem: Failing to actively manage working capital in the months before closing can lead to significant negative adjustments.
The solution: Once a target is established, implement strategies to optimize working capital before closing:
Accelerate collection of accounts receivable
Manage inventory levels carefully
Time large purchases strategically
Consider negotiating payment timing with vendors
Case study: Jennifer's retail business historically maintained $450,000 in working capital. In the three months before closing, she implemented aggressive A/R collection procedures and optimized inventory ordering, resulting in closing working capital of $520,000. This strategic management generated an additional $70,000 payment at closing.
Negotiation Strategies for Favorable Working Capital Terms
Now that you understand the common pitfalls, here are specific strategies to negotiate working capital provisions in your favor:
Strategy #1: Negotiate a "Collar" or Buffer Zone
What it is: A range around the target where no adjustment occurs.
How it works: If your target is $300,000, you might negotiate a 5% collar, meaning no adjustment for actual working capital between $285,000 and $315,000.
Why it's valuable: This eliminates haggling over small differences and provides flexibility.
Strategy #2: Define Clear Calculation Methodology
What to specify:
The exact accounts included
Accounting methods to be used
Treatment of specific items (like aged receivables)
Who will prepare the closing balance sheet
Dispute resolution procedures
Pro tip: Include examples of the calculation based on recent historical periods to avoid misunderstandings.
Strategy #3: Consider Seasonality Adjustments
What it is: An adjustment to the target based on historical patterns for the closing month.
Example: If your business typically carries 20% more inventory in Q4 than the annual average, your Q4 working capital target would be adjusted upward by 20%.
When it's critical: For highly seasonal businesses where working capital fluctuates significantly throughout the year.
Strategy #4: Push for Exclusion of Subjective Items
Items to exclude:
Reserve accounts that involve estimation or judgment
Disputed amounts
Items that are valued differently under different accounting methods
Why it matters: Including subjective items creates opportunity for post-closing disputes.
Strategy #5: Negotiate a Cap on Adjustments
What it is: A maximum limit on how large the working capital adjustment can be.
Example language: "In no event shall the working capital adjustment exceed $X."
Strategic value: This limits your downside risk while still providing the buyer reasonable protection.
Industry-Specific Working Capital Considerations
Working capital needs vary dramatically by industry. Here are typical working capital patterns and considerations for common business types:
Manufacturing
Typical working capital needs: 20-30% of annual revenue Key components: Inventory (raw materials, WIP, finished goods), A/R Special considerations:
Inventory obsolescence calculations
Long production cycles can inflate WIP
Customer deposits treatment
Seasonality of raw material purchasing
Pro tip: Watch for inventory "true-ups" that might occur around closing date.
Professional Services
Typical working capital needs: 10-20% of annual revenue Key components: A/R, work in progress, prepaid expenses Special considerations:
WIP recognition practices
Lumpy billing cycles
Employee bonus accruals
Treatment of retainers
Pro tip: Push for exclusion of subjective accruals like performance bonuses from working capital calculations.
Distribution
Typical working capital needs: 15-25% of annual revenue Key components: Inventory, A/R, vendor payments Special considerations:
Seasonality of inventory purchasing
Vendor rebate programs
Volume discount accruals
Inventory in transit
Pro tip: Ensure the methodology for inventory valuation is clearly defined, including treatment of slow-moving items.
Retail
Typical working capital needs: 15-20% of annual revenue Key components: Inventory, credit card receivables, gift cards Special considerations:
Seasonal inventory build-ups
Gift card/store credit liabilities
Return reserves
Vendor credit terms
Pro tip: Consider negotiating separate treatment for seasonal inventory if you're selling during peak inventory periods.
Construction
Typical working capital needs: 5-15% of annual revenue Key components: Contract receivables, retainage, customer advances Special considerations:
Percentage-of-completion accounting
Retainage treatment
Claims and change orders
Subcontractor payment timing
Pro tip: Pay special attention to the treatment of underbilling and overbilling in working capital calculations.
Practical Tools: Working Capital Analysis and Management
To put these strategies into practice, here are specific tools and approaches to help you analyze and manage your working capital before sale:
Working Capital Analysis Spreadsheet
Create a spreadsheet that tracks:
Monthly working capital for 24-36 months
Breakdown by major component (A/R, inventory, A/P, etc.)
Seasonal patterns and trends
Calculation of historical averages
This becomes the foundation for establishing a fair target and identifying optimization opportunities.
Pro tip: Calculate working capital as a percentage of trailing 12-month revenue to identify efficiency trends.
Working Capital Projection Model
Develop a model to forecast working capital through expected closing date based on:
Revenue and cost projections
Historical collection and payment patterns
Planned operational changes
Specific working capital management strategies
This helps you anticipate and plan for the likely working capital position at closing.
Working Capital Management Checklist
Implement these actions in the months before closing:
Accounts Receivable:
Accelerate collections without damaging customer relationships
Identify and resolve disputed invoices
Consider early payment incentives for large accounts
Review credit terms for new orders
Inventory:
Optimize ordering to reduce excess inventory
Identify and sell or write off obsolete items
Time receipt of major orders strategically
Consider vendor consignment arrangements
Accounts Payable:
Analyze timing of payments vs. terms
Consider extending payment timing where appropriate
Evaluate early payment discounts vs. cash conservation
Communicate with key vendors about any changes
Pro tip: Start implementing working capital management strategies 3-6 months before anticipated closing to establish new patterns without appearing to manipulate closing numbers.
Real-World Case Study: How Proper Working Capital Planning Added $275,000 to a Sale
To illustrate the financial impact of proper working capital planning, consider this real case study (with names changed):
Business: Regional industrial supply company with $10M annual revenue Purchase price: $7.5M (before working capital adjustments) Initial LOI terms: Standard working capital provision with target based on trailing 12-month average
The Challenge: The seller, David, noticed the LOI included a standard working capital clause but no specifics. Analysis of historical working capital revealed:
Wide monthly fluctuations ($800K to $1.2M)
Clear seasonal pattern (higher in summer, lower in winter)
Closing likely during peak season (June)
Several one-time items distorting the trailing average
The Strategy: With his advisors, David:
Renegotiated the LOI to specify:
Seasonal adjustment formula
Exclusion of one-time items
5% collar around target
Cash to be excluded
Implemented working capital management plan:
Accelerated collections on aged receivables
Negotiated extended payment terms with key suppliers
Delayed non-essential inventory purchases
Strategically timed capital expenditures
The Result:
Original proposed target: $1M (simple 12-month average)
Renegotiated target: $1.15M (with seasonal adjustment for June)
Actual closing working capital: $950K
Financial Impact:
Without planning: $50,000 payment to buyer ($1M target - $950K actual)
With planning: $200,000 payment to seller ($950K actual vs. seasonally-adjusted target of $1.15M plus collar provision)
Net improvement: $250,000
Additional benefit: The clear methodology prevented a 60-day dispute over the calculation, allowing faster payment of escrow funds worth another $25,000 in interest-related opportunity cost.
Total Value Added: $275,000
Key Takeaways: Maximizing Value Through Working Capital Management
As you prepare for your business sale, remember these critical working capital principles:
Start early – Address working capital in the LOI stage, not just final purchase agreement
Know your patterns – Analyze historical working capital to identify trends and seasonality
Negotiate methodology – Define exactly how working capital will be calculated and which items are included/excluded
Plan strategically – Implement working capital management strategies 3-6 months before closing
Document everything – Keep clear records of any unusual working capital items or events
Seek expert help – Working with M&A advisors experienced in working capital negotiations can pay for itself many times over
Remember: Working capital adjustments can easily represent 5-15% of your total deal value. Putting time and effort into understanding and optimizing this aspect of your transaction can add hundreds of thousands of dollars to your final proceeds—money that rightfully belongs in your pocket rather than the buyer's.
Your Action Plan: Next Steps
Ready to start optimizing your working capital for maximum sale value? Here's a practical action plan:
Immediate Actions (Next 30 Days)
Analyze historical working capital for the past 24-36 months
Identify seasonal patterns and any unusual items
Calculate your average working capital as a percentage of revenue
Review your LOI or purchase agreement for working capital provisions
Consult with your M&A advisor about working capital negotiation strategy
Pre-Closing Actions (3-6 Months Before Closing)
Implement accounts receivable acceleration strategies
Optimize inventory levels without disrupting operations
Review accounts payable timing
Document any non-recurring working capital items
Create projected working capital models through closing
Working capital may seem like a technical afterthought in the excitement of selling your business, but savvy sellers know it can make or break their final payout. By understanding, planning, and negotiating this critical aspect properly, you'll ensure you receive the full value you've worked so hard to build.
