*as published in Crain’s Cleveland – download the print version

When selling a business, the transaction price usually represents some multiple of the income and cash flow of the company. In exchange for this consideration, the buyer expects to receive three classes of assets:

  • Fixed assets needed to generate future cash flows
  • Intangible assets (such as trade name, trained workforce and goodwill)
  • Working capital

While it can be fairly straightforward to understand fixed assets and intangible assets, working capital is a more nuanced concept and something of a moving target.

Strictly defined, working capital is the current assets of the company netted against its current liabilities.

Buyers generally want to ensure that enough working capital is being left behind to maintain the company’s operations. An immediate shortfall in working capital can damage banking relationships and unsettle investor confidence. Sellers, on the other hand, want to minimize the amount of working capital delivered.

The following steps taken by a seller will save both the buyer and seller significant time and effort:

Understand what makes up your working capital

One of the most common guidelines is to make sure that each item you consider as a current liability is offset by a current asset. If you believe you have excess working capital, be ready to explain why it was not distributed. Be aware that for purposes of an M&A transaction, cash, credit lines and the current portion of longterm debts are often excluded.

Get benchmarks

The buyer is surely doing research on a target for working capital as part of due diligence. Beat him to it by doing your own research to see how your company measures up.

Identify trends

What is your monthly average for working capital for the past year? Look also at several years back. What is the trend in working capital? Consider the future, too — compute a forecast of working capital so that you can reasonably judge the validity of what your buyer calculates. Study historical current ratios and the ratio of your working capital to sales.

Anticipate obstacles at closing

Has your reported level of inventory been accurate in the past? Do you have slow moving inventory or inventory that fluctuates in value? Will a detailed analysis of your accounts receivables reveal bad-debt issues? As the seller, you need to put yourself in the buyer’s shoes and anticipate possible objections.