Defining Working Capital
Working capital (also referred to as net working capital), is a liquidity ratio that measures a company’s ability to pay off its current liabilities with its current assets. Working capital is calculated by subtracting current liabilities from current assets.
The beginning of the final negotiations between a buyer and seller in a business deal is agreeing on a purchase price, but it’s not the end. Without significant changes in the day-to-day operation, theoretically, nothing should change. But often times the balance sheet can tell a different story.
In smaller business deals, it’s assumed the seller retains cash, receivables, and pays off the liabilities. The buyer purchases any leftover inventory at an agreed-upon price. In a lot of transactions, many buyers see it differently and feel the need to add more cash into the deals to sustain liquidity. They see balanced or negotiated receivables to retain cash flow while assuming the liabilities deducted from the purchase price.
In some transactions, this can be a sticking point that needs an early resolution or it can be a deal killer, especially if the transaction is project-related. An early resolution, even before going to market, can avoid late red flags.
