Why does Working Capital Adjustment matter?
Without it, a seller could quietly drain cash, delay paying bills, or accelerate collections in the weeks before closing to inflate what the buyer is effectively paying for. The adjustment mechanism, and the accounting methodology used to calculate it, determine whether the final price reflects the business the buyer is actually closing on rather than one dressed up for the sale, and disputes over this mechanism are a common source of post-closing conflict.
What does Working Capital Adjustment look like in practice?
Suppose a deal sets a working capital peg of $500,000 based on trailing twelve-month averages. At closing, actual working capital comes in at $350,000 because the seller delayed paying several vendor invoices to preserve cash before the sale. The buyer is owed a $150,000 downward adjustment to the purchase price to cover the shortfall, money it will now need to fund those overdue payables itself, exactly what the peg is designed to prevent.
What are the common mistakes with Working Capital Adjustment?
- Not agreeing on the working capital calculation methodology (which accounts count, which accounting standard applies) until a dispute has already started.
- Setting the peg based on a period that does not reflect the business's normal seasonal cycle, creating a false shortfall or surplus.
- Assuming the adjustment is symmetric in practice, sellers often push harder to dispute a downward adjustment than they contest an upward one.
- Treating the post-closing adjustment process, and its dispute-resolution mechanism, as a formality rather than negotiating it as carefully as the price itself.
Related concepts
- Quality of Earnings (QoE) ReportAn independent analysis, commissioned by a buyer during diligence, that normalizes a target's reported earnings to reveal what is actually recurring and sustainable, stripping out one-time items, accounting choices, and related-party transactions that inflate the headline number.
- Financial Statement Audit vs. Review vs. CompilationThree escalating levels of assurance an outside accounting firm can provide on financial statements, a compilation organizes management's numbers with no assurance, a review offers limited assurance, and an audit independently verifies the underlying transactions.
- Asset Sale vs. Stock SaleThe two basic ways to structure an acquisition, the buyer purchases specific assets and liabilities out of the company (asset sale), or the buyer purchases the company's equity itself, liabilities included (stock sale), and the choice changes who owns what, who owes what, and how much tax each side pays.