Working Capital Adjustments: The Quiet Mechanism That Moves Real Money at Closing

Working capital is the most overlooked line item in most M&A deals. Founders focus on the headline price. They focus on the escrow. They focus on indemnification and reps and warranties. And then, sixty days after closing, a spreadsheet arrives showing that the working capital delivered fell short of the agreed target by four hundred thousand dollars — and that money is now owed back to the buyer.

The working capital adjustment is the quiet mechanism by which real money moves at closing. It can be material — sometimes the difference between a great outcome and a disappointing one — and it is almost entirely a function of how the relevant provisions are drafted, not how the seller has run the business.

What working capital actually means in an M&A context

Net working capital is current assets minus current liabilities — a measure of the operating liquidity the business needs to function. In an M&A transaction, the buyer expects to receive the business with enough working capital to keep operating the day after closing. If working capital is depleted at closing, the buyer effectively has to inject cash to keep the business running, and that injection is value the buyer did not bargain for.

The working capital adjustment is the mechanism that solves this problem. The parties agree on a target — the amount of working capital the seller commits to deliver at closing — and the purchase price is adjusted dollar-for-dollar based on the difference between the target and the actual amount delivered.

How the target gets set

The target is usually negotiated based on the trailing twelve months of monthly working capital, often expressed as an average. The logic is straightforward: working capital fluctuates month-to-month based on seasonality, customer collection patterns, and operating cycles, and the average smooths those fluctuations into a single representative number.

There are several traps in this calculation worth understanding before agreeing to a target:

Trailing period selection

If the business has been growing, the trailing twelve months reflect a smaller business than the one being acquired. If the business is seasonal and closing happens just after a peak, recent months overstate the steady-state need. The right trailing period depends on the business, and it is worth negotiating.

Which accounts are included

Standard working capital excludes cash and debt — those are dealt with separately as part of the equity calculation. But what about deferred revenue? Customer deposits? Income taxes payable? Each of these is an accrual that may or may not represent a true operating obligation, and including or excluding them moves the target meaningfully. Define each one explicitly.

Non-recurring items

If the trailing twelve months include unusual events — a large customer paying unusually late, a one-time inventory build, an acquisition-related expense — those events distort the target. Negotiate normalization adjustments for non-recurring items, and document them in the working capital exhibit.

The working capital exhibit is where most of the actual money is decided. It deserves more attention than it usually gets.

The closing process: estimate, deliver, true up

The actual mechanics typically run like this. A few days before closing, the seller delivers an estimated closing balance sheet, which determines the initial purchase price adjustment. Cash actually changes hands based on that estimate.

Within sixty to ninety days after closing, the buyer prepares a final closing balance sheet, reflecting actual working capital as of the closing date. Any difference between the estimate and the final calculation results in a true-up payment in one direction or the other. If the parties disagree about the final calculation, the disagreement is resolved through the dispute process in the purchase agreement — usually escalating to an independent accounting firm.

Where the disputes actually happen

Working capital disputes rarely involve outright errors. They almost always involve judgment. The most common disputed items:

Accounts receivable collectibility

An old receivable on the books may or may not be collectible. The seller wants to include it at full value; the buyer wants to write it down. The standard approach is to apply an agreed reserve methodology — for example, fully reserving receivables more than ninety days past due — but the methodology has to be in the agreement. Leaving it to be applied ‘consistently with past practice’ is an invitation to dispute.

Inventory valuation

Is the inventory carried at the right value? Is any of it obsolete or slow-moving? Should an obsolescence reserve apply? Each judgment moves the number. For inventory-heavy businesses, the working capital exhibit should specify exactly how inventory will be valued and what reserves will apply.

Accrued expenses

What liabilities are accrued as of closing? Vacation pay? Bonuses? Warranty obligations? Contingent liabilities? Each of these accruals reduces working capital and thereby reduces the price. Sellers should expect buyers to find accruals the seller did not record, and the agreement should specify what kinds of accruals are required and what kinds are not.

Accounting policy changes

The most contested area in practice. The seller has been running the business under a consistent set of accounting policies. The buyer, applying its own policies or a different interpretation of GAAP, calculates the closing balance sheet differently. The result is a different working capital number — sometimes dramatically different. The agreement should require that the closing balance sheet be prepared using the same accounting policies the seller has historically used, with any exceptions explicitly listed.

What sellers should negotiate in the working capital provisions

Several specific provisions consistently matter:

• Definition of working capital with each account category specifically listed.
• Methodology for setting the target, including the trailing period and any normalization adjustments.
• Requirement that the closing balance sheet be prepared using the seller’s historical accounting policies, applied consistently.
• A cap on the adjustment, or at minimum a deductible below which no adjustment is made.
• A defined dispute resolution process with a binding accounting firm determination.
• A reasonable buyer review period — sixty days is more common than ninety, and shorter is better for the seller.

The pre-closing playbook

Once the working capital target is set, the seller has a real interest in delivering at or above the target at closing. That is not gaming the system — it is meeting the deal that was struck. In the weeks before closing, a thoughtful seller manages working capital actively: collecting receivables promptly, managing inventory levels, ensuring accruals are appropriately recorded. There is nothing wrong with any of this as long as it is done in the ordinary course.

What sellers should not do is engineer artificial spikes in working capital that distort the calculation. Buyers will catch it, the indemnification claims will follow, and the resulting dispute will erase any short-term gain. The goal is to deliver the business as the parties bargained for it — and to ensure the agreement reflects what ‘as bargained for’ actually means.

Frequently Asked Questions

What is a working capital adjustment in an M&A deal?

A working capital adjustment is a post-closing true-up of the purchase price based on the difference between the actual working capital delivered at closing and an agreed target amount. If the seller delivers more working capital than the target, the price goes up. If less, it goes down.

How is the working capital target set?

Most commonly, the target is set at the average net working capital over a defined trailing period — typically the trailing twelve months. The methodology should be defined in detail in the purchase agreement, including which accounts are included, how they are calculated, and what adjustments apply.

Why does working capital generate so many disputes?

Because the underlying accounts — accounts receivable, inventory, accrued expenses — involve judgment. Is a particular receivable collectible? Is inventory obsolete? Are certain liabilities truly accrued at closing? Each judgment moves the number, and both sides have an incentive to read the judgments their way.

Should working capital methodology be defined in the LOI or in the purchase agreement?

The conceptual framework should be in the LOI. The detailed methodology — including the specific accounts, calculation rules, and any exclusions — belongs in a working capital exhibit to the purchase agreement. Leaving the details for later is one of the most common drafting mistakes in M&A.

Who calculates working capital at closing?

Typically the seller delivers an estimated closing balance sheet a few days before closing. The buyer prepares a definitive closing balance sheet within sixty to ninety days after closing. Any disagreement triggers the dispute resolution process specified in the purchase agreement, usually escalating to an independent accounting firm.

About the Author

Scott Levine is the Founder and Managing Partner of AEGIS Law, a national law firm built on a fundamentally different model: lawyers focus exclusively on practicing law while a dedicated management team runs the business. Scott has spent nearly thirty years guiding entrepreneurs, founders, and closely held companies through mergers, acquisitions, growth transactions, and exits. He works alongside the firm’s M&A team — including Rochelle Walk, Robert Gold, and others — across AEGIS offices in St. Louis, Chicago, Denver, Tampa Bay, and Southern Illinois. He can be reached through aegislaw.com.