- Working capital is generally calculated as current assets minus current liabilities — things like accounts receivable, inventory, and prepaid expenses, less accounts payable, accrued…
- The parties agree on a target working capital figure during negotiation, often based on a trailing average of the business's historical working capital levels.
Two businesses can look identical on the surface — same revenue, same assets, same purchase price — and still hand the buyer very different starting positions on day one. The difference often comes down to working capital: the cash, receivables, inventory, and short-term liabilities the buyer actually receives (or inherits) at closing.
A working capital adjustment is one of the most common — and most commonly misunderstood — mechanics in an Ontario business sale. Get it wrong, and you can end up paying full price for a business that's short on the operating cash it needs to function from day one.
This article explains what a working capital target is, why it exists, and what buyers should actually check before signing off on the closing numbers.
What Working Capital Means in a Deal
Working capital is generally calculated as current assets minus current liabilities — things like accounts receivable, inventory, and prepaid expenses, less accounts payable, accrued expenses, and other short-term obligations.
The core idea behind a working capital adjustment: the purchase price is negotiated assuming the business will be delivered with a certain "normal" level of working capital at closing — enough to keep operating without the buyer needing to inject fresh cash immediately. If the actual working capital at closing comes in above or below that target, the purchase price is adjusted to compensate.
- Working capital above target — the seller has left more net current assets in the business than expected, and the purchase price typically increases to compensate the seller.
- Working capital below target — the business has less cushion than expected, and the purchase price typically decreases to compensate the buyer.
How the Mechanism Usually Works
- The parties agree on a target working capital figure during negotiation, often based on a trailing average of the business's historical working capital levels.
- An estimated closing statement is prepared just before or at closing, giving an initial estimate of actual working capital and triggering an initial price adjustment (up or down) against the target.
- A final closing statement is prepared some time after closing, based on the books as of the closing date, once final figures are available.
- The two statements are reconciled, and a true-up payment is made between buyer and seller to account for any difference between the estimated and final figures.
- Disputes over the final statement, if they arise, are typically resolved according to a process set out in the purchase agreement — commonly referral to an independent accountant to determine the disputed items.
What Buyers Should Verify
| Item | Why it matters |
|---|---|
| How the target figure was calculated | A target based on a cherry-picked period (e.g., the business's best month) can be set artificially high, working against the buyer |
| What counts as a "current" asset or liability | Definitions vary — confirm inventory, prepaid items, and accrued liabilities are treated consistently with how the target was calculated |
| Accounting policies used | The closing statement should be prepared using the same accounting methods as the historical figures the target was based on, or the comparison is meaningless |
| Collectability of receivables included in the count | Aged or doubtful receivables inflate the working capital figure without reflecting real value |
| Timing of the count | A closing statement prepared weeks after closing may not reflect the business as it actually was on the closing date |
| The dispute resolution process | Confirm there's a clear mechanism (often an independent accountant) if buyer and seller disagree on the final numbers |
Common Points of Dispute
- Inventory valuation feeding into the working capital number — see the related question of how inventory itself is counted and valued, since an inflated inventory figure inflates working capital too.
- Accrued liabilities left off the closing statement — unpaid vacation pay, unbilled supplier invoices, or accrued bonuses that should reduce the working capital figure but weren't captured.
- One-time or unusual items included or excluded inconsistently between the target calculation and the actual closing statement.
- Receivables that turn out to be uncollectible after closing, raising the question of whether they should have been excluded from the working capital count in the first place.
These disputes are exactly why the purchase agreement needs precise, unambiguous definitions of working capital, the target, and the calculation methodology — vague language here is one of the most frequent sources of post-closing disagreement in a business sale.
Frequently asked questions
Is a working capital adjustment used in every business sale?
No. It's most common in deals of meaningful size where the buyer needs assurance the business will have adequate operating cash at closing. Smaller, simpler transactions sometimes forgo a formal adjustment mechanism entirely, particularly where the purchase price already reflects an estimate baked in.
What if the seller and I can't agree on the target figure?
This is negotiated like any other deal term, usually with reference to the business's recent historical working capital levels over a representative period. If the parties can't agree during negotiation, this is a signal to get accounting advice before proceeding, since a disputed target rarely resolves itself cleanly after closing.
Who typically prepares the closing statement?
This varies by deal — sometimes the seller prepares it with buyer review rights, sometimes the buyer prepares it post-closing with seller review rights. The purchase agreement should specify who prepares it, what access the other party has to supporting records, and how long each side has to raise objections.
What happens if we can't resolve a dispute over the final numbers?
Most purchase agreements specify a resolution process for financial disputes — commonly, referral to an independent accountant whose determination is binding, avoiding a full litigation or arbitration process over what is ultimately an accounting disagreement.
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