LUTZ BUSINESS INSIGHTS
net working capital: what is it and how is it used?
bill kenedy, LUTZ consulting and m&a shareholder
A commonly misunderstood topic in M&A transactions is the concept of net working capital (NWC). This is recognized as a predetermined amount of capital that is included in the purchase price in a business sale transaction. Understanding what NWC encompasses and how this amount is calculated is an important step in the M&A process.
What is Net Working Capital?
Net Working Capital is a measure of operating liquidity available to a business at a given point in time. Major NWC accounts include accounts receivables, inventory and accounts payable. In short, it can be calculated as your business’s current assets (less cash) minus its current liabilities. Here is an example calculation for NWC:
Net Working Capital in Business Transactions
In most transactions, NWC stays with the company being acquired as it is considered a necessary operating asset of the business. However, by monthly tracking of collections, payments, and inventory levels, sellers of a business can minimize the amount of money locked up in NWC in order to retain more cash when the business sells.
For example, if the selling company has historically paid its vendors in 15 days even though they have 30 day payment terms, the company could adjust their payment timing to increase cash on hand and reduce NWC. This change would need to occur well before starting an M&A process (more than a year).
The reason for needed to work on your NWC well before embarking on an M&A process is that most buyers will require a NWC peg based on the company’s historical averages.
A problem with relying on historical results is that the information can often be skewed. Seasonality, peaks and troughs, can often affect the validity of a company’s historical results of NWC. To get a more accurate estimate, buyers will establish “trends” by analyzing a company’s historical NWC over a 12-18 month period.
Overall, not understanding and addressing net working capital issues earlier in the M&A process could have a significant impact on the business transaction and the ultimate amount of cash the seller realizes from the transaction. If you have any questions regarding net working capital, please contact Lutz M&A.
ABOUT THE AUTHOR
BILL KENEDY + LUTZ CONSULTING AND M&A SHAREHOLDER
Bill Kenedy is a Lutz Consulting and M&A Shareholder at Lutz. He specializes in business valuation, litigation support, and merger and acquisition advisory services.
AREAS OF FOCUS
AFFILIATIONS AND CREDENTIALS
- American Institute of Certified Public Accountants, Member
- Nebraska Society of Certified Public Accountants, Member
- Certified Public Accountant
- Accredited in Business Valuation
- Certified in Financial Forensic
- Certified Exit Planning Advisor
- BSBA in Accounting, St. John’s University, Collegeville, MN
- Construction Financial Management Association, Past Treasurer, Board Member
- A Time to Heal (non-profit focused on cancer patients), Past Board Member
- Am I Ready to Sell My Business?
- Lutz M&A Advises Wings on its Acquisition by Eagle's Landing
- Selling Your Business? The Financial Information Buyers Want to See
- Can My Business Run Without Me?
- Finding the True Value of Your Business
- How Does the Business Sale Process Work?
- Understanding the Tax Implications of a Business Sale
- The M&A Client Experience
- Lutz M&A Advises Midwest Scaffold Service on its Sale to Sunbelt Rentals
- 5 Key Purchase Agreement Considerations
- Net Working Capital: What is it and How is it Used?
- Issues During the Due Diligence Process in M&A Transactions
- Lutz M&A Advises Fantasy's, Inc. on its Acquisition by Casey's General Stores
- Primary Benefits of Selling Your Company to an ESOP
- Is An Employee Stock Option Plan Right for Your Business?
- Lutz M&A Advises C&W Transportation on its Sale to Platform Capital
- Our Services, Our People, and Our Results
- Lutz M&A Advises Hands of Heartland on its Recent Investment by Evolve Capital
- Lutz M&A Advises Labor Source on its Recapitalization by Great Range Capital
- Overcoming Obstacles in Business Transition Planning
- Understanding Net Working Capital in Business Transactions
- How to Increase the Value of Your Business
- When is the Right Time to Exit My Business?
- Lutz M&A Advises Triage Staffing on Recapitalization
- Lutz M&A Advises Hockenbergs on Recent Sale to Trimark USA LLC
- Lutz M&A Advises Focus Respiratory on its Recent Buyout by Valley Healthcare Group
- Is Your Small Business at Risk of Fraud?
- Lutz M&A Advises CCW, LLC on its Recent Buyout
- Lutz M&A Advises NIFCO Mechanical Systems on Recent Sale
- Lutz M&A Advises Midwest Door & Hardware on Recent Sale
- Why is Forensic Accounting Needed?
SIGN UP FOR OUR NEWSLETTERS!
We tap into the vast knowledge and experience within our organization to provide you with monthly content on topics and ideas that drive and challenge your company every day.
13616 California Street, Suite 300
Omaha, NE 68154
747 N Burlington Avenue, Suite 401
Hastings, NE 68901