Working Capital at Closing: Define the Peg Before Comparing the Price

Define what the price includes

A business can report earnings while the buyer still needs cash to collect receivables, replenish inventory and pay the next payroll. Begin with the proposed transaction: which operating assets and obligations are delivered, who retains cash and debt, and how any difference from the agreed target changes the consideration?

Do not start by copying total current assets less total current liabilities from the balance sheet. That accounting subtotal may contain accounts that the deal excludes or treats elsewhere. A negotiated population might include eligible trade receivables, usable inventory, operating prepayments, trade payables and customer deposits. It might treat taxes, accrued compensation, debt, deferred revenue or WIP differently. The agreement must settle the actual definition.

Create an account-level map

Give every included account an owner, sign convention, cutoff and evidence reference. Keep a separate exception log for uncertain balances. The WIP guide helps distinguish work performed, billed amounts and work still to complete.

Use history to understand the operating cycle

The companion workbook has a 24-month schedule. Apply the same definition to every month before comparing its average, range or closing balance. Investigate acquisitions, accounting changes, unusual purchasing, storm work, delayed billing and unusual collections. An incomplete month should remain unavailable rather than appear as a genuine zero balance.

Review months at similar points in the business cycle. A landscaping operator’s winter balances and summer payroll funding may differ. A project contractor can have a temporary receivable or retainage spike. Neither the trailing average nor the highest month automatically becomes the contractual target. Record why the parties select a target and what operating conditions it is meant to support.

A closing-adjustment example

Hypothetical included population: $120,000 eligible receivables + $40,000 inventory + $15,000 prepayments − $65,000 payables − $30,000 customer deposits = $80,000. Against a separately negotiated $100,000 target, the mathematical adjustment is negative $20,000.

The workbook’s illustrative 24 months range from $70,000 to $115,000, with a $90,000 average. Its $100,000 target is an editable example, not a conclusion from that average. The schedule is intentionally useful for comparing the definition, history and negotiated amount instead of silently equating them.

Whether the negative adjustment reduces the seller’s payment, comes from escrow or is settled later depends on the agreement. If a particular customer deposit is already included in this calculation, identify why a second price deduction for the same obligation would be justified before applying it.

Separate the peg from day-one funding

The adjustment compares delivered balances with an agreed target. The buyer’s liquidity schedule asks when receipts arrive and payments fall due. Receivables delivered at closing do not fund payroll until collected. Inventory may support service but cannot pay a lender installment.

Use the acquisition cash-flow tool for monthly receipts and payments. Identify the funding reserve separately in uses of funds. When direct receipts and operating payments already reflect collection and supplier timing, do not also deduct the same working-capital movement without a reconciliation. Keep a price adjustment distinct from an operating cash-flow use.

Make the settlement process reviewable

1. Attach an example calculation and account definition to the transaction documents.
2. Agree the measurement time, inventory/receivable procedures and accounting hierarchy.
3. Identify who prepares the estimate and final statement, and how supporting records are delivered.
4. Record review, objection, dispute and payment procedures in the actual agreement.
5. Track each disputed account, the competing amount, evidence and resolution.

A publicly filed 2005 agreement, section 2.04, illustrates the specificity of account definitions and statement/objection procedures. It concerns another industry and period. Its categories and deadlines are an example of contract drafting, not a rule for an Illinois home-services sale.

Bring a complete review file

Prepare monthly trial balances, account mapping, subledgers, reserve policies, later receipts/payments, physical counts, service obligations and the proposed closing statement. Identify gaps explicitly. Ask accounting and legal advisers to reconcile the definition with the asset/equity structure, tax allocation and seller-proceeds waterfall. This framework does not select a fair target or replace the agreement.

Sources and scope

Source links support the specific topics noted. Examples and analytical frameworks are illustrative; confirm current requirements and transaction facts with the responsible advisers.

1. SEC EDGAR — 2005 asset-purchase agreement, section 2.04
   Historical, cross-industry example of negotiated working-capital definitions and adjustment procedures. It is not an Illinois contractor rule, model agreement or market benchmark.
2. Internal Revenue Service — Form 8594
   Reporting qualifying asset acquisitions and the conditions for buyer/seller filing.