A working capital adjustment is a common but often misunderstood part of buying or selling a business. It ensures that the business is delivered with enough operating funds, and it can change the final price by a meaningful amount after closing.
What a working capital adjustment does
Working capital is generally the difference between current assets, such as cash, receivables, and inventory, and current liabilities, such as payables. A business needs a normal level of it to operate day to day.
In a purchase agreement, the parties usually agree on a target level. If the business delivers more than the target at closing, the price may increase, and if it delivers less, the price may decrease.
Why the working capital adjustment matters
Without an adjustment, a seller could collect receivables, delay paying bills, or reduce inventory just before closing, leaving the buyer to fund operations from day one. The adjustment protects the buyer from that and gives sellers a clear rule for what is expected.
It also prevents arguments after closing about whether the business was handed over in a normal condition.
How the target is usually set
Parties often look at the average working capital over a recent period, such as the previous twelve months, to account for seasonality. A business with strong seasonal swings may need a target that reflects the time of year when the sale closes.
Agree in advance on which accounts count and how they will be measured. Accounting methods should match those used in the financial statements reviewed during due diligence.
- Which assets and liabilities are included
- The period used to calculate the average
- How inventory and receivables are valued
- Treatment of cash, debt, and taxes
- Who prepares the closing statement and how disputes are resolved
Common mistakes to avoid
Vague definitions are the biggest problem. If the agreement does not say how to value inventory or treat unpaid taxes, the parties may disagree later. Another mistake is setting the target without reviewing seasonal patterns, which can shift value unfairly.
Make sure the adjustment is based on the same accounting rules used throughout the deal.
Get help with the working capital adjustment
An accountant with transaction experience and an attorney should help draft the working capital adjustment clause. Review it alongside the letter of intent and purchase agreement, and use our guides on due diligence and valuation to prepare your questions. Clear terms save money and relationships.
More guidance on the working capital adjustment and deal terms
- How to Buy an Existing Business: A Due Diligence Guide
- How to Value a Business Before You Buy: Multiples and Seller’s Discretionary Earnings
- Working With a Business Broker: How to Find One and What It Costs
- SBA guide to planning your business
- Earnout Agreement: How It Works in a Business Sale
- Business Broker Commission: How Fees Work for Sellers
- Buying a Business Opportunity: A Complete Step-by-Step Guide
Further reading: Investor.gov and Federal Reserve.
Keep reading
If this topic is useful to you, these related guides on SmartBizOpps are a good next step.
