Net working capital (NWC) is a crucial financial metric that reflects the funds available to cover short-term operational obligations within a business. It plays a significant role in various aspects of a company's operations, including managing vendor payments, stocking inventory, and meeting payroll requirements. The level of working capital can vary considerably overtime due to factors such as seasonal fluctuations, shifts in customer demand, supply availability, pricing changes, and unexpected events.

In the context of an acquisition, working capital often forms part of the purchase price, with a mechanism in place to adjust for any differences between the agreed-upon working capital target (or "peg")and the actual amount at the closing date. While NWC is typically calculated as current assets minus current liabilities, its determination in a transaction setting can be more intricate and involve various adjustments. These adjustments may include definitional adjustments (e.g., aligning with a cash-free/debt-free transaction), diligence adjustments (e.g., accounting for non-operating or non-recurring items), and pro-forma adjustments (e.g., recalculating NWC balances based on updated assumptions).

Understanding the components of working capital and the factors driving its fluctuations is essential to ensure that a business maintains adequate levels of working capital from day one without disruptions or the need for additional cash injections. Establishing an appropriate peg at closing through comprehensive documentation in the sale and purchase agreement is critical for minimizing post-closing disputes and adjustments. By carefully managing working capital considerations during acquisitions, businesses can enhance their financial stability and operational efficiency.

April 8, 2024