Understand Net Working Capital: Get More Cash at Closing
When preparing to sell, business owners often hear the same advice: “You need to prepare your financial statements.” But what does that really mean?
Your revenue and profit trends are important. But there’s another number—often overlooked—that can have a big, direct impact on how much cash you put in your pocket at closing: Net Working Capital.
Many owners know what NWC is, but they are most likely not managing it with a business sale in mind.
What is Net Working Capital in a Transaction?
Net Working Capital (NWC) is easily stated: Current Assets less Current Liabilities.
NWC is what the business has on hand to run the day-to-day operations. Simply put, NWC is considered an “Asset” of the business.
For a transaction, it is made up of familiar line items. For example: Accounts Receivable, Inventory, Prepaid Expenses, Accounts Payable. In most transactions, buyers expect the business to come with a “normalized” level of these items so operations can continue smoothly after the sale.
Cash & Debt are generally not considered part of NWC in a transaction.
How is it calculated?
In general sense, it can be calculated as:
For discussion purposes, if you take this math formula and then average the Trailing 12-months, you will get what is commonly called “The Peg” or “NWC Peg”. This is what a buyer will expect to be delivered at closing.
If you deliver more than the peg, you get more money at closing.
If you deliver less than the peg, you get less money at closing.
But, don’t worry if you deliver less than the peg. It isn’t always bad. More on this later…
Why should I care about NWC Peg?
Many offers will read, “Buyer will give $$$$ for the business stock(or assets), on a cash-free/debt-free basis, with normalized NWC delivered at closing.”
Notice the Purchase Price will not change if you have a higher or lower “Peg”. Therefore, can you increase your cash-at-closing by lowering your peg? The answer: YES!!!
How do I lower my NWC?
Every business is unique. You are the expert and have built a successful business! I should get advice from you. However, here are some examples of things to consider:
Accounts Payable: You are a good business owner. You pay your bills early. However, from a transaction view, it increases the NWC of the business. Therefore, pay on time and not early, if it is a good idea for your business and doesn’t harm relationships or discounts.
Inventory: There are advantages of buying in bulk. However, from a transaction view, excess inventory increases your NWC. Also, depending on your bookkeeping procedures, it could decrease your profitability.
Conclusion
Preparing your financials for a sale means more than polishing your income statement. Net Working Capital is a key driver of what you’ll take home at closing. At Fidelis Advisors, we guide business owners through these critical details to ensure the best possible outcome.
If you want to know more about this topic or dig deeper and learn why under delivery of NWC may not be a bad thing, get ahold of us. We are happy to help.
