Working capital adjustment

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Why working capital matters in a sale

A buyer expects the business to have enough normal operating assets and liabilities to continue trading. If receivables or stock are unusually low, or trade creditors unusually high, the buyer may need extra cash immediately. Conversely, more working capital than the agreed target may have value to the buyer under the agreed mechanism.

The adjustment is not a general judgement about whether the business is well run. It is a contractual calculation. The agreement determines the included accounts, accounting policies, target, completion date and process for resolving differences.

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Define net working capital before setting a target

A common transaction measure includes agreed operating current assets less agreed operating current liabilities. Cash, debt and tax balances may be dealt with elsewhere, but there is no universal list. Deferred revenue, customer deposits, employee-related balances and provisions often need explicit treatment.

Prepare an account-by-account schedule. State whether each item belongs in working capital, cash, debt or another adjustment. Do not count the same item twice. A balance-sheet label alone may not explain the economic obligation, especially when cash has been received for work still to be performed.

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Set the working capital peg

The peg is the agreed target against which completion working capital is compared. Historical monthly data can help establish normal requirements, but an average is only a starting point. Consider seasonality, growth, billing cycles, changes in payment terms and unusual balances.

Review stock quality and overdue receivables as well as their totals. A business with obsolete stock or doubtful debts may not have the operating resources implied by the headline balance. A working capital review helps connect the accounts with how the business trades.

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A worked working capital adjustment

Assume a hypothetical agreement defines working capital as receivables plus inventory less trade payables. At completion, the agreed balances are $250,000, $180,000 and $130,000 respectively. Completion working capital is $300,000. The target is $280,000.

This simplified NZD example assumes a dollar-for-dollar adjustment with no collar, cap or other rule. If completion working capital were $260,000 instead, the same mechanism would reduce the price by $20,000. The actual agreement controls the calculation.

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Completion accounts vs locked box

Completion accounts determine specified balances at the completion date, often using an estimated payment followed by a later true-up. The process needs clear preparation deadlines, access to records, review rights and dispute steps.

A locked-box structure uses an agreed historical balance sheet to set the price, with provisions dealing with value leaving the business between that date and completion. It is not simply a working-capital adjustment with a different name. The appropriate mechanism depends on information quality, transaction circumstances and the negotiated agreement.

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Prepare a clean completion schedule

• Agree definitions and accounting policies before negotiating the number.
• Reconcile the historical data used to support the target.
• Document seasonal and growth effects.
• List excluded, unusual and disputed balances explicitly.
• Confirm how stock counts, provisions and cut-off will be handled.
• Check the relationship with cash, debt and other price adjustments.
• Assign responsibility for the estimate, final calculation and review.

The enterprise-to-equity value bridge shows where these adjustments may sit in a broader price discussion. We help owners connect completion mechanics with the commercial terms of selling a business in NZ.