HOW TO CALCULATE WORKING CAPITAL IN THE SALE OF A LOWER MIDDLE MARKET BUSINESS

Calculating working capital in the context of a lower middle market business sale involves assessing the company's current assets and liabilities. Working capital is a measure of a company's operational liquidity and short-term financial health. Here's a simplified guide in point form for calculating working capital in the context of a business sale:

1.    Identify Current Assets:

a.    List all current assets, including:

b.    Cash and cash equivalents

c.     Accounts receivable

d.    Inventory

e.    Prepaid expenses

2.    Quantify Current Liabilities:

a.    Identify and list current liabilities, such as:

b.    Accounts payable

c.     Short-term debt

d.    Accrued expenses

e.    Current portion of long-term debt

3.    Exclude Non-Operating Assets and Liabilities:

Exclude non-operating assets or liabilities that are not part of normal business operations.

4.    Calculate Working Capital:

Working Capital = Current Assets – Current Liabilities

5.    Review Working Capital Adjustments:

Determine if there are any agreed-upon adjustments or specific items excluded or included in the working capital calculation, as per the terms of the sale agreement.

6.    Consider Industry Norms:

Assess whether the calculated working capital aligns with industry norms and standards. This may involve industry benchmarks or comparisons with similar businesses.

7.    Understand Working Capital Requirements:

Analyze the specific working capital requirements of the business. Some industries may require higher working capital levels due to the nature of their operations.

8.    Working Capital Target:

Determine if there is a target working capital amount specified in the sale agreement. The buyer and seller may negotiate a target working capital level, and adjustments to the sale price could be based on any variance from this target.

9.    Working Capital Adjustment Mechanism:

Establish the mechanism for working capital adjustments. This may involve a post-closing adjustment where the final working capital is determined after the sale, and the purchase price is adjusted accordingly.

10.  Engage Financial Professionals:

In complex transactions, involve financial professionals, such as accountants or financial advisors, to ensure accuracy and adherence to accounting principles.

11.  Document the Calculation:

Clearly document the working capital calculation methodology, adjustments, and any other relevant details in the sale agreement to avoid disputes and ensure clarity.

It's crucial to note that the specific terms and conditions for calculating working capital can vary based on the agreements reached between the buyer and seller during the negotiation and due diligence process.

Therefore, it's recommended to consult with financial professionals and legal advisors to ensure accuracy and compliance with the terms of the business sale agreement. For access to financial professionals that can assist you with calculating the working capital in your business sale in the US and Canada, simply CLICK on the button below.