The Price Agreed in the Contract Is Not the Money That Changes Hands
Deals are priced on an assumed level of working capital. The adjustment at closing settles the difference, and it is the last chance either side has to move real money.
Why an Adjustment Exists at All
Acquisitions are almost always priced on a cash free debt free basis. The buyer values the operating business, then assumes it will receive that business with a normal amount of working capital in it, neither stripped nor stuffed.
Working capital is the money tied up in running the business day to day: receivables owed by customers, plus inventory, less payables owed to suppliers. It fluctuates constantly. Between signing a deal and closing it, weeks or months pass, and the level moves.
Without an adjustment, a seller could collect every receivable, sell inventory without replacing it and delay paying suppliers, delivering an emptied business at the agreed price.
The Mechanics
The parties agree a target level of working capital, typically the average over the twelve months before signing, intended to represent a normal operating level. At closing, actual working capital is measured, and the price moves dollar for dollar against the target.
| Situation | Effect on price |
|---|---|
| Actual above target | Buyer pays the seller the excess |
| Actual below target | Seller refunds the shortfall |
Because the closing accounts take time to prepare, the process runs in two stages. An estimate is used to determine the amount wired at closing, and a final calculation is produced afterwards, usually within sixty to ninety days, with a true up payment settling the difference.
Setting the Target
The target is where most of the negotiating value sits, because it is a single number that moves the price directly and it is set on judgement rather than fact.
Seasonality is the first complication. A retailer builds inventory before a peak season and runs it down afterwards, so a twelve month average may bear no relation to the level on a specific closing date. A business closing in November against an annual average target may show enormous apparent excess working capital, and a buyer that accepted a simple average will pay for it.
Growth is the second. A rapidly growing business needs more working capital each month, so a trailing average understates the correct level and systematically favours the buyer.
The third is the definition itself. Which balance sheet lines count as working capital is negotiated, and items such as accrued bonuses, deferred revenue, tax balances and disputed receivables are argued over precisely because their classification moves money.
Deferred Revenue and the Double Count
One recurring dispute deserves specific attention. Deferred revenue is cash the target has already collected for services it has not yet delivered. It is a liability, and if included in working capital it reduces the seller proceeds.
Sellers argue it should be excluded, since the cash was collected in the ordinary course and the obligation is an operating one already reflected in the earnings the price was based on. Buyers argue they are inheriting a delivery obligation funded by cash the seller kept. Both positions are arguable, and the outcome depends on negotiating strength rather than principle.
Where the Real Leverage Sits
The party that prepares the closing statement has a meaningful advantage, because the other side must find and challenge each item within a limited review window. Buyers usually insist on preparing it, since by closing they control the business and its records.
The seller protections that matter are a defined and reasonably long review period, full access to the underlying books, an agreed set of accounting policies fixed at signing so the calculation cannot be changed by method, and an independent accountant to resolve disputes with a defined scope.
That last point matters more than it appears. Without agreed policies, a buyer can apply more conservative reserve estimates to receivables and inventory at closing than the target historically used, reducing measured working capital and clawing back price through accounting judgement rather than through anything that changed in the business.
The Alternative
Some transactions, particularly in Europe, avoid the whole mechanism using a locked box structure. The price is fixed based on a historical balance sheet date, the seller warrants that no value has leaked out since, and there is no post closing adjustment. It provides certainty and shifts the risk of the intervening period to the buyer, who must be comfortable with the diligence they did on that earlier balance sheet.
The Bottom Line
The working capital adjustment is the last and least glamorous negotiation in a transaction and routinely the one where the largest sums move after the headline price is set. The target level, the definition of which items count, the treatment of deferred revenue and the accounting policies applied at closing are where the value is decided. A party that negotiates the price carefully and the adjustment casually has left the final word to the other side.