Working capital is one of those concepts that seems simple until you’re actually selling a business. Then it becomes complicated and contentious. Understanding it upfront can save you thousands of dollars.
Working capital is the cash the business needs to operate on a day-to-day basis. It’s current assets minus current liabilities: cash plus receivables plus inventory, minus what you owe vendors and creditors. It’s the money that keeps the lights on.
When you sell a business, working capital is transferred at cost. The buyer doesn’t pay a markup on working capital like they do on profit. They’re paying for the cash and assets needed to run the business, and they’re assuming the liabilities. It’s a neutral transfer, in theory.
The Basic Concept
Let’s say your business has:
Current Assets:
- Cash: $50,000
- Accounts receivable: $80,000
- Inventory: $40,000
- Total: $170,000
Current Liabilities:
- Accounts payable: $50,000
- Accrued payroll: $20,000
- Total: $70,000
Working Capital = $170,000 - $70,000 = $100,000
This $100,000 is working capital. The buyer needs this much cash and receivables to run the business. They also assume the $70,000 in payables.
In the purchase agreement, you typically agree on a “target working capital”—the amount the buyer expects to find at closing. If the actual working capital is higher, the buyer pays you the difference. If it’s lower, you pay the buyer back.
Why Working Capital Gets Disputed
This is where it gets complicated. Working capital calculations can be interpreted different ways:
How do you value accounts receivable? At face value? Or do you write off accounts that are past due or questionable? A buyer might argue that receivables that are 90+ days old shouldn’t count at full value.
What counts as cash? Do restricted funds count? What about sales tax payables the business collected but hasn’t paid to the state? Those reduce available cash.
What about accrued expenses? An accrued liability might be estimated. Did you accrue payroll correctly? Bonuses? Vacation time? Buyers will scrutinize these.
Inventory valuation — Is inventory at cost or at selling value? If inventory is obsolete or slow-moving, should it be marked down?
Post-closing adjustments — How do you verify working capital if it depends on post-closing activity? If a customer pays a receivable after closing, whose money is it?
These questions are why working capital disputes happen. Two reasonable people looking at the same financials can disagree on what working capital actually is.
Setting Target Working Capital
Smart sellers agree on a specific working capital target before going to market. You might work with your accountant to calculate “normalized working capital”—what the business typically needs to operate.
For example: “Normalized working capital for this business is $75,000 based on a three-year average.”
Then in the purchase agreement, you agree: “The business will be sold with target working capital of $75,000. At closing, the parties will calculate actual working capital. If actual is higher, buyer pays seller the difference. If actual is lower, seller pays buyer the difference.”
This gives both sides clarity. You know what’s expected. The buyer knows what they’re getting.
Common Disputes and How to Avoid Them
Receivables write-off — The buyer claims some receivables aren’t actually collectible and writes them off. You disagree.
Avoid this by being conservative with your receivables aging. If something is 90 days past due, it’s probably not fully collectible. Don’t count on getting paid.
Inventory obsolescence — The buyer claims inventory is obsolete and should be written off.
Avoid this by cleaning up inventory before closing. Don’t overstock. Mark down or donate obsolete inventory before sale.
Payables timing — You accrued a payable in December for December services, but the vendor didn’t invoice until January.
Avoid this by using clear accrual practices. Your accountant should review accruals to make sure they’re reasonable and standard.
Cash reserves — The buyer claims you should have left more cash in the business.
Avoid this by discussing normalized working capital upfront. “The business typically operates with $50K in cash reserves. That’s what we’re targeting.” Then actually leave that cash.
Post-closing adjustments — Receivables collected after closing, inventory sold after closing—how are these handled?
Avoid this by specifying in the agreement: “Working capital is calculated at closing using balance sheet as of [closing date]. Post-closing collections and sales are buyer’s property.”
Negotiation Strategy
When a buyer proposes working capital terms, pay attention:
Agree on target working capital early. Before the LOI. Ideally before you go to market. “The business operates with approximately $50,000 in working capital. That’s what the buyer will receive.”
Define exactly how working capital is calculated. “Working capital is calculated per attached Schedule, which shows how each asset and liability is valued.” No ambiguity.
Include dollar thresholds. “Adjustments to purchase price will be made for working capital variance in excess of $5,000.” Don’t let the buyer claim against you for minor differences.
Limit the survival period for working capital adjustments. “Any working capital adjustment claims must be made within 30 days of closing.” Don’t let this drag on.
Have your accountant prepare the closing balance sheet. Not the buyer’s accountant. You have more insight into your business, and you want favorable assumptions applied.
The Practical Reality
In practice, working capital adjustments don’t usually equal the purchase price. If your business sells for $500,000 and working capital is $50,000, the working capital adjustment might be $5,000 to $10,000 either way. It’s not huge.
But disputes over $10,000 happen all the time. The buyer’s accountant writes off $15,000 in receivables. Your accountant says they’re collectible. You argue. Months go by.
Avoid this by being meticulous about working capital before closing. Know your numbers. Document assumptions. Have your accountant review the closing balance sheet. And include clear, specific language in the purchase agreement about how it’s calculated.
Working capital seems like a technical accounting issue, but it’s one of the most frequent sources of post-closing disputes. Get it right upfront and you’ll save yourself headache and money later.