The Working Capital Question: How to Protect Deal Value in M&A Transactions

Bringing clarity, consistency, and financial discipline to one of the most negotiated elements of a transaction.

Mergers and acquisitions are built around agreed expectations. A buyer agrees to pay a particular price based on its understanding of the business being acquired, while the seller expects to deliver that business under an agreed set of financial and operational conditions. Working capital is naturally an important part of that equation.

According to PwC’s June 2026 US Deals Midyear Outlook, US M&A deal value reached $1.2 trillion during the first five months of 2026, nearly double the $603 billion recorded during the same period in 2025, despite deal volume declining by 4%. Those figures point to a market in which significant capital continues to be deployed, but buyers and sellers are becoming increasingly selective about the transactions they pursue.

In this environment, every detail of a transaction matters. Working capital adjustments are commonly used in M&A transactions to help ensure that a business is delivered with an appropriate level of short-term operating assets and liabilities at closing. In principle, the concept is relatively straightforward. In practice, determining the appropriate working capital target and calculating the final adjustment can become one of the more complicated and contentious parts of a transaction.

With a good understanding of this, buyers, sellers, and their advisors can reduce uncertainty and help to prevent post-closing disputes.

Why working capital matters in a transaction

A buyer generally expects to acquire a business with sufficient working capital to continue operating under ‘normal’ conditions after closing. If working capital is significantly below the agreed level, the buyer may have to inject additional cash into the business immediately. Conversely, if the seller delivers more working capital than required, the seller may reasonably expect to receive value for that excess.

The purchase agreement will therefore often establish a target, sometimes referred to as a working capital peg, against which actual working capital at closing is compared. If closing working capital exceeds the target, the purchase price may increase. If it falls below the target, the purchase price may decrease. That mechanism helps bridge the period between agreeing on the headline purchase price and determining the financial position of the business on the closing date.

Establishing the right working capital target

Setting an appropriate target requires more than taking a snapshot of the company's balance sheet. Historical financial information can provide a good starting point. Accounts receivable, inventory, accounts payable, accrued expenses, and other relevant balances can be reviewed over an appropriate period to identify the company's normal working capital requirements.

But historical averages do not always tell the whole story. A seasonal business, for example, may naturally carry substantially different inventory or receivable balances at different points in the year. Rapid growth or contraction can also make older financial periods less representative of current requirements.

Additionally, one-time events may need to be considered. Unusual customer payments, delayed vendor invoices, non-recurring expenses, or changes in accounting practices can distort historical balances. A good analysis seeks to distinguish normal operating requirements from anomalies that should not influence the target.

Accounting consistency can become a point of contention

Many working capital disputes arise because buyers and sellers disagree over how particular balances should be treated.

The purchase agreement should establish the accounting principles and methodologies governing the calculation, but applying those principles after closing can still require judgment. Questions may arise over reserves for doubtful accounts, obsolete inventory, accrued liabilities, prepaid expenses, customer deposits, or other balance sheet items.

Consistency is particularly important. If, for instance, the working capital target was calculated using historical accounts receivable balances with a consistent allowance for doubtful accounts, but the closing calculation applies a significantly more conservative reserve for potentially uncollectible receivables, closing working capital could appear lower even though the underlying business has not materially changed. The buyer and seller would no longer be comparing working capital on a like-for-like basis. Even relatively small methodological differences can have a big effect on the final purchase price when significant balances are involved.

Looking beyond the headline numbers

Working capital analysis can also provide important insight into the underlying quality of a business.

A sudden improvement in working capital immediately before closing would warrant closer examination. Accounts payable could have been delayed, collection activity accelerated, or inventory purchases postponed. Some fluctuations may be entirely consistent with ordinary operations, but others can temporarily improve the balance sheet without representing a sustainable change in the business.

The same applies from the seller's perspective. A closing calculation that applies more conservative reserves or classifications than those historically used by the company could reduce working capital and therefore the final purchase price.

For this reason, effective analysis considers not only the reported numbers but also the activity behind them. Understanding historical trends, accounting policies, cash conversion cycles, and operational changes can provide a more complete picture of what constitutes normalized working capital.

This broader assessment also connects closely with business valuation. Due diligence around price, terms, and liabilities is a common application of valuation work, and working capital can form an important part of that wider financial picture.

Preventing post-closing disputes

Although working capital adjustments are designed to create fairness between buyer and seller, post-closing disputes can arise when the parties interpret calculations or classifications differently.

Early financial due diligence can help reduce that risk. Clearly defining which assets and liabilities are included, identifying the applicable accounting principles, and establishing a supportable working capital target all provide greater certainty before the transaction closes.

The underlying calculations should also be documented carefully. When assumptions and methodologies are transparent from the beginning, both parties have a clearer framework against which the final adjustment can be evaluated.

When to get financial expertise

Working capital adjustments may represent only one component of an M&A agreement, but they can have a significant impact on the amount ultimately paid or received. Historical averages, seasonality, accounting policies, unusual transactions, and changes in business performance can all influence the appropriate target and closing calculation, making what appears to be a straightforward mechanism considerably more complex in practice.

Experienced financial advisors can help buyers and sellers analyze historical working capital, identify unusual items, evaluate proposed targets, and review post-closing calculations. The objective is to ensure that the calculation reflects the economic intent of the transaction and is supported by consistent, well-documented financial analysis. Addressing these issues early can reduce uncertainty, limit disputes, and provide greater confidence in the final economics of a deal.

Nevin Sanli has been a financial consultant for over 40 years, specializing in forensic accounting, business, brand & IP valuations, fairness & solvency opinions and transaction advisory services.

For further information and advice, contact Nevin at:

nsanli@sphvalue.com

(310) 571-3400