When buyers evaluate an acquisition, most of the attention goes to revenue, EBITDA and the multiple. Working capital tends to come up later, often when the lawyers start drafting the price adjustment clause.
That is usually too late. In our experience at Hillpine, across more than 100 transactions in India, the UK, Europe, the US, Australia and the Middle East, working capital is one of the most common reasons the price agreed at term sheet stage is not the price that is finally paid. It moves value between buyer and seller, often by more than either side expected.
Net working capital is the cash tied up in running the business day to day. In simple terms, it is trade receivables plus inventory, less trade payables, together with other operating items such as prepayments and accruals. How it is defined, measured and agreed in the deal has a direct effect on value.
Here is what we look at, and why it matters to both sides of a transaction.
1. Profit Does Not Always Mean Cash
A business can report good revenue and EBITDA, but that does not necessarily mean cash is coming in on time.
Take a company that has booked strong sales, but whose customers take 90 to 120 days to pay. The revenue is in the profit and loss account, but the cash is sitting in receivables. Meanwhile, salaries, suppliers and rent still have to be paid every month.
This can put pressure on cash flow even when the business is profitable.
In due diligence, we track days sales outstanding, days inventory outstanding and days payables outstanding month by month, and compare operating cash flow with EBITDA. When profit and cash move in different directions, working capital is usually where the explanation sits.
2. Receivables and Inventory Need a Closer Look
Receivables and inventory can take up a significant amount of a company’s cash.
Buyers should look at the receivables ageing, not just the total. Rising debtor days can point to collection problems, looser credit terms used to win sales, or disputes with customers. We also check credit notes issued and cash received after the period end. A receivable that is later credited or never collected was never really an asset.
Inventory needs the same discipline. Slow-moving or obsolete stock, inventory carried at outdated costs, or a weak year-end count can all overstate the balance. If the business has not provided for these items, working capital, and often EBITDA too, is higher than it should be.
These issues may not be immediately obvious from the profit and loss statement. A closer review of working capital helps buyers understand whether the reported current assets are actually useful and recoverable.
3. Agree the Definition Before You Agree the Number
The most negotiated part of working capital is often not the number, but what goes into it.
Items such as deferred revenue, customer advances, accrued bonuses, income tax payable, overdue supplier balances and related-party balances can sit either in working capital or in net debt. Where they land changes the price. If an item is counted in both, the seller pays for it twice. If it is left out of both, the buyer ends up absorbing it.
The definition, the accounting policies used to calculate it and the treatment of each balance sheet line should be set out in the transaction documents, ideally with an illustrative calculation attached. It saves a great deal of argument after closing.
4. How Working Capital Moves the Price
Working capital is not just an operational matter. It can also directly affect the financial terms of an acquisition.
In most deals, buyer and seller agree a normal level of working capital that the business should be delivered with at closing. This is the working capital peg, or target. The logic is simple. The buyer is paying for a business that can operate normally from day one without needing extra cash.
Under a completion accounts mechanism, which is common in the US and India, actual working capital at closing is compared with the peg. If it falls short, the price comes down, usually rupee for rupee or dollar for dollar. If it is higher, the seller receives more. Many deals add a collar or a de minimis threshold so that small differences do not trigger an adjustment.
Under a locked box mechanism, which is more typical in the UK and Europe, there is no adjustment after the deal. The price is fixed on a historical balance sheet, so the buyer has to be satisfied that working capital on that date was at a normal level, and that value cannot leak to the seller between the locked box date and completion.
Either way, a peg set slightly too low or too high can shift the economics of a deal more than most buyers or sellers expect. It deserves the same scrutiny as the EBITDA multiple.
5. Seasonality and Growth Can Distort the Picture
Working capital can change throughout the year, depending on the nature of the business.
A retailer builds stock ahead of the holiday season, whether that is Christmas, Diwali or Ramadan. A manufacturer needs more cash in peak production months. An agribusiness may collect most of its cash in the few months after harvest.
Looking at working capital on just one date may not give buyers a complete picture.
We base the peg on average monthly balances over at least 12 months, adjusted for one-off items, and look closely at where in the seasonal cycle the deal is expected to close.
Growth needs the same attention. A fast-growing business needs more working capital every year. A peg based on last year’s average may be too low for next year’s activity, leaving the buyer to fund the gap. Sellers, for their part, will argue that the peg should reflect the business as it is today, not as it might be.
6. Watch the Months Before Closing
Working capital is one of the easiest numbers to manage in the run-up to a sale, sometimes by accident and sometimes on purpose.
A seller may chase collections hard, delay paying suppliers or run down stock ahead of closing. In a cash-free, debt-free deal, the extra cash usually goes to the seller, while the buyer inherits a business that has to restore normal supplier terms and rebuild inventory. Stretched payables can also make historical working capital look lower than it really is, which pulls the peg down.
Buyers should review payment terms, overdue payables, recent changes in supplier or customer terms, and the trend over the last few months. Where the historical numbers have been flattered, the peg should be set on a normalised basis.
7. Working Capital Is Also a Value Lever
Working capital issues do not always mean that a business is performing poorly. Sometimes, there is room to improve how the business manages its cash.
Faster collections, better inventory planning and more effective payment management can help release cash tied up in day-to-day operations.
For a private equity buyer, a credible working capital improvement plan can release cash early in the holding period and support returns. For a founder preparing to sell, the same discipline pays off in a different way. Collecting or writing off old receivables, clearing dead stock and arriving with a defensible peg before going to market puts the seller in a much stronger negotiating position.
Working Capital Is Part of the Price
Working capital rarely gets the same attention as revenue or EBITDA, but it decides how much cash the business needs, whether its current position is sustainable and, in the end, how much the buyer really pays.
The definition, the peg and the price mechanism should be worked through during due diligence, not left for the closing statement. By then, most of the leverage has gone.
At Hillpine, our ex-Big 4 team supports buyers, sellers and advisory firms on financial due diligence, working capital analysis and peg negotiations across India, the UK, Europe, the US, Australia and the Middle East. If you are working through a transaction and want a clear view of working capital, we would be glad to talk.