Protecting the Value of the Deal
How to Resolve Working Capital Disputes in Transactions
In 2016 and 2017, over 80 percent of purchase price adjustments in M&A transactions involved working capital adjustments, according to SRS Acquiom's 2018 Deal Term Study. The purchase and sale agreement (PSA) commonly includes a purchase price adjustment provision to address differences between the target working capital expected by the buyer at the time the PSA is signed and the working capital received by the buyer at closing. Disputes often arise between the buyer and the seller as to the proper determination of the working capital based on the closing balance sheet.
This article explains how working capital is calculated, how working capital is included in the purchase price, how disputes arise in the calculation of working capital, and how accountants can assist the buyer and seller in resolving working capital disputes.
Calculating Working Capital
Working capital, also referred to as net working capital, is the difference between current assets and current liabilities shown on the balance sheet. Working capital measures how well the business can support its short-term financial needs through various company activities, including revenue collection, debt management and inventory management.
Current assets are cash and other assets that are reasonably expected to be realized in cash or sold or consumed during the normal operating cycle of the business. The normal operating cycle is usually a year but can be longer in certain instances. Liabilities are classified as current when the liquidation of such liabilities is reasonably expected to require the use of existing resources properly classifiable as current assets or to create other obligations.