- Matt Bodnar
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- Understanding Net Working Capital: The Lifeblood of Every Deal
Understanding Net Working Capital: The Lifeblood of Every Deal
If you’re buying a business (or running one), net working capital (NWC) is one of the most critical—and misunderstood—concepts you’ll encounter. Mastering it can save you from headaches during an acquisition and help you unlock value in your portfolio.
What Is Net Working Capital?
At its core, NWC is the cash tied up in the day-to-day operations of a business. It’s calculated as:
NWC = Current Assets – Current Liabilities
Current Assets: Cash, accounts receivable, inventory, and prepaid expenses—cash you expect to get.
Current Liabilities: Accounts payable, accrued expenses, and short-term debts—cash you need to pay.
A positive NWC means a business has enough liquidity to operate smoothly. A negative NWC signals that the business may struggle to meet short-term obligations, relying on outside funding to stay afloat.
Why NWC Matters in Acquisitions
When you’re acquiring a business, Net Working Capital ensures the company can operate seamlessly from Day 1 without needing immediate cash infusions. But here’s where things get tricky: buyers and sellers often disagree on how much working capital the business needs at closing.
This is where the NWC Peg comes into play.
What Is an NWC Peg?
The NWC peg is a baseline level of working capital that both parties agree is necessary for the business to operate normally. It’s based on historical NWC levels and trends.
Why It’s Important:
For Buyers: Without a peg, you risk inheriting a business with insufficient working capital—leaving you to plug cash flow gaps immediately after closing.
For Sellers: A clearly defined peg ensures they aren’t penalized for seasonal swings or over-efficient management of working capital pre-sale.
At closing, the actual NWC is compared to the agreed-upon peg:
If NWC > Peg, the seller often gets a bonus.
If NWC < Peg, the purchase price is adjusted downward to make up for the shortfall.
How NWC Impacts Business Health
Healthy NWC (Positive NWC):
Current assets exceed current liabilities.
The business has enough cash or liquidity to fund operations, cover expenses, and support growth.
Example: A wholesale distributor maintains lean inventory, collects payments quickly, and negotiates favorable terms with suppliers.
Unhealthy NWC (Negative NWC):
Current liabilities exceed current assets.
The business struggles with cash flow, relying on loans or equity injections to keep running.
Example: A manufacturer carries excess inventory and gives customers long payment terms but must pay suppliers quickly—creating cash gaps.
NWC Adjustments in Acquisitions
Here’s why the peg matters so much:
Imagine buying a business expecting it to have $1M in NWC, but on closing day, you find only $500k—cash you’ll now need to inject just to keep operations running. A well-negotiated NWC peg avoids this situation by aligning expectations and protecting both parties.
Key Tip: Always analyze historical NWC trends (e.g., seasonality, growth impact, or operational shifts) to set a fair peg.
The Takeaway
Net working capital is the fuel that keeps a business running. In acquisitions, a clear NWC peg ensures you’re buying a functional operation, not a cash drain. For operators, managing NWC well means smoother growth, better cash flow, and increased value.
Need help analyzing an NWC peg or structuring a deal? Let’s connect.
-Matt
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