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Working Capital Guide

Working Capital in M&A: A Seller’s Guide to Getting it Right

When you’re selling your business, working capital might seem like a minor detail compared to the final sale price. But here’s the truth: getting working capital wrong can cost you millions after the deal closes.

This guide will help you avoid that fate.

What is Working Capital (In Plain English)?

Working capital is the money your business needs to run day-to-day operations. Think of it as your business’s checking account balance. It’s typically calculated as:

Current Assets - Current Liabilities = Working Capital

In other words: what you own minus what you owe in the short term.

Three Core Principles for Getting Working Capital Right

1. Consistency is Everything

The biggest mistakes happen when sellers use different methods to calculate working capital at different times. Pick one approach and stick to it. If you’ve been recording revenue one way for years, don’t switch methods right before the sale.

Simple rule: Whatever accounting method you’ve been using, keep using it through the sale process.

2. Documentation Beats Memory

Every assumption, every calculation, every decision about working capital needs to be written down. This isn’t about creating paperwork – it’s about protecting yourself.

Simple rule: If it isn’t documented, it didn’t happen.

3. Details Matter More Than You Think

Small accounting decisions you make today can lead to big disputes tomorrow. Pay special attention to:

  • Employee bonuses and commissions
  • Insurance reserves
  • Warranty costs
  • Seasonal business fluctuations
  • Mid-month closing adjustments

A Pre-Sale Checklist That Will Save You Money

Before You Start Negotiations:

  1. Calculate your normal working capital over the past 12 months
  2. Identify any unusual events that affected your working capital
  3. List all your accounting policies in writing
  4. Get your accounting team ready to help after the sale closes

During Negotiations:

  1. Define exactly what counts as working capital
  2. Specify which accounting standards you’ll use
  3. Set clear rules for handling disputed items
  4. Consider setting minimum and maximum adjustment limits

Before Closing:

  1. Prepare detailed supporting documents for all calculations
  2. Record everything on an accrual basis
  3. Check with all departments for undocumented obligations
  4. Save copies of all supporting documents

Understanding the GAAP Factor

Most buyers will expect your working capital to be calculated using Generally Accepted Accounting Principles (GAAP). Here’s what you need to know:

The GAAP Baseline

Think of GAAP like the rules of the road. It’s the standard way of doing accounting in the US. But just like local traffic laws can vary by state, your business might have its own accounting quirks that differ from strict GAAP.

Simple rule: Document any differences between your current accounting methods and GAAP.

Key GAAP Considerations for Working Capital:

  1. Revenue Recognition

    • When do you record a sale? On delivery? When you invoice? When cash comes in?
    • If your method differs from GAAP, your working capital target needs to reflect this

  2. Inventory Valuation

    • GAAP requires specific methods for valuing inventory
    • Your current method might need adjustment for the sale

  3. Accounts Receivable

    • How do you handle bad debt reserves?
    • GAAP typically requires more conservative estimates

Making the Switch

If you need to adjust your numbers to GAAP, remember:

  • Your working capital target should reflect these adjustments
  • Historical numbers might need recalculation
  • Document every change you make

Pro tip: Consider creating a “GAAP bridge” document that shows how your normal accounting converts to GAAP standards. This can prevent disputes later.

Common Pitfalls to Avoid

The “We’ll Figure It Out Later” Trap

Vague agreements lead to expensive disputes. Be specific about everything in writing.

The “It’s Just an Estimate” Mistake

Your closing estimates matter more than you think. Put the same care into them as your final numbers.

The “That’s Not How We Usually Do It” Problem

Stick to your normal accounting practices. Last-minute changes usually backfire.

Special Accounting Items to Watch

Mid-Month Closings

If your deal closes mid-month, you’ll need clear rules for:

  • Payroll accruals
  • Revenue recognition
  • Expense allocation
  • Monthly subscriptions or recurring charges

Simple rule: Specify whether you’ll use calendar days or business days for calculations.

Seasonal Adjustments

If your business is seasonal, your working capital needs will vary throughout the year. Make sure your target reflects:

  • Historical seasonal patterns
  • The timing of your closing
  • Normal business cycles
  • Peak vs. off-peak requirements

Non-Recurring Items

Some items don’t belong in your working capital calculation:

  • One-time expenses
  • Extraordinary events
  • Non-operational assets
  • Tax assets and liabilities

Final Thoughts

Working capital adjustments aren’t just about math – they’re about protecting the value you’ve built in your business. Get them right, and you’ll avoid painful post-closing disputes. Get them wrong, and you might find yourself giving back part of your sale price.

Remember: The best time to think about working capital is long before you’re sitting at the closing table.

Want to get this right? Start by documenting your current working capital calculation method today. It’s the first step to a smoother sale process tomorrow.