What is a working capital adjustment, and why does it cost sellers money at closing?

Most purchase agreements set a target for the working capital the business must hand over on the closing day. If the business delivers less than the target, the price comes down by the difference, dollar for dollar. It costs sellers money when the target is set higher than the business normally carries, and the seller finds out after the price is agreed.

Working capital here usually means receivables and inventory, less payables and accrued costs. The buyer is paying for a business that can run the day after closing without new cash going in. The target, often called the peg, is meant to be a normal level. The argument is over what normal is.

It goes wrong in a few familiar ways. The peg is set from a month-end that was unusually high. The business is seasonal and nobody worked out the swing. Items get included or left out differently from how the business actually keeps its books. Or the seller never did the calculation, so the buyer’s number becomes the starting point.

The adjustment is settled after closing, when the seller has the least room to push back and the most distraction. If you know the business’s normal working capital, month by month, before you sign a letter of intent, the peg is a calculation rather than an argument.

What you can look at this week: take the last twenty-four monthly balance sheets. For each month, add receivables and inventory and subtract payables. Look at the range, the average, and when in the year it peaks. That swing is what a buyer will negotiate.