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  1. Home
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  3. Managing Your Net Working Capital

Managing Your Net Working Capital

Posted by Margaret Amsden and Ben Smith on February 2, 2018

Margaret Amsden

When a business is considering selling there are many elements to be managed. One of the elements that should be closely monitored is called Net Working Capital (NWC). A unique issue related to NWC is that, if not properly managed in the years leading up to a sale, the seller could end up leaving significant value on the table.

Essentially, NWC is the current assets (inventory, accounts receivable, prepaid expenses) of a company in excess of the current liabilities (trade payables, accrued wages, etc.). Within a specific transaction, items normally included in this definition may be specifically excluded from the definition agreed to by the parties. Some of the common exclusions include cash, refundable tax payments, or related party receivables and/or payables. Since NWC is what allows a company to operate day to day, a buyer wants to make sure that there is sufficient NWC to allow the company to operate in the days immediately following a transaction. To accomplish this the buyer will generally set a target for the NWC. The agreements will require the buyer to pay for any excess NWC and require that the seller make up any NWC shortfall. This prevents sellers from altering the value of a company by driving down receivables, or letting payables build up, in the days leading up to a transaction.

With this background in mind, managing NWC maximizes proceeds on a sale, NWC should be maintained at as low of a level as feasible to operate the business. Some of the items to consider include:

  • Is the company carrying excess inventory?
  • Is the company prepaying expenses that don’t need to be prepaid?
  • Is the company paying payables significantly ahead of their due date?
  • Is the company fully accruing expenses at the end of a period?

Importantly, when a purchaser conducts their due diligence, it is common to look at the NWC amounts over a trailing 12 to 18 month period, and set a target for NWC based on an average of that period. This reinforces why it is important to manage the NWC of a business, well before a transaction is expected to occur. Recognizing that it takes time to true up prepaid amounts and book accruals on a monthly basis, it becomes key as a business is approaching a transaction to assure that these adjustments are made accurately on a monthly basis.

In the process of managing NWC prior to a transaction, it may become evident that there are valid reasons for a company to carry excess NWC. For example:

  • Excess inventory may be carried due to significant quantity discounts to be obtained or there may be certain inventory that is scarce
  • Accounts payable may be lower than customary to take advantage of early payment discounts.

In these situations it is important to be able to articulate to a buyer so that the proper NWC targets are set. Contact us if you need assistance in determining or computing a normalized NWC for your industry.

Our team is always ready to help.

Please contact us for more information.

Margaret Amsden

Shareholder, Private Client Services

Contact Margaret   |   Read Margaret's bio

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Managing Your Net Working Capital

Posted by Margaret Amsden on February 2, 2018

Margaret Amsden

When a business is considering selling there are many elements to be managed. One of the elements that should be closely monitored is called Net Working Capital (NWC). A unique issue related to NWC is that, if not properly managed in the years leading up to a sale, the seller could end up leaving significant value on the table.

Essentially, NWC is the current assets (inventory, accounts receivable, prepaid expenses) of a company in excess of the current liabilities (trade payables, accrued wages, etc.). Within a specific transaction, items normally included in this definition may be specifically excluded from the definition agreed to by the parties. Some of the common exclusions include cash, refundable tax payments, or related party receivables and/or payables. Since NWC is what allows a company to operate day to day, a buyer wants to make sure that there is sufficient NWC to allow the company to operate in the days immediately following a transaction. To accomplish this the buyer will generally set a target for the NWC. The agreements will require the buyer to pay for any excess NWC and require that the seller make up any NWC shortfall. This prevents sellers from altering the value of a company by driving down receivables, or letting payables build up, in the days leading up to a transaction.

With this background in mind, managing NWC maximizes proceeds on a sale, NWC should be maintained at as low of a level as feasible to operate the business. Some of the items to consider include:

  • Is the company carrying excess inventory?
  • Is the company prepaying expenses that don’t need to be prepaid?
  • Is the company paying payables significantly ahead of their due date?
  • Is the company fully accruing expenses at the end of a period?

Importantly, when a purchaser conducts their due diligence, it is common to look at the NWC amounts over a trailing 12 to 18 month period, and set a target for NWC based on an average of that period. This reinforces why it is important to manage the NWC of a business, well before a transaction is expected to occur. Recognizing that it takes time to true up prepaid amounts and book accruals on a monthly basis, it becomes key as a business is approaching a transaction to assure that these adjustments are made accurately on a monthly basis.

In the process of managing NWC prior to a transaction, it may become evident that there are valid reasons for a company to carry excess NWC. For example:

  • Excess inventory may be carried due to significant quantity discounts to be obtained or there may be certain inventory that is scarce
  • Accounts payable may be lower than customary to take advantage of early payment discounts.

In these situations it is important to be able to articulate to a buyer so that the proper NWC targets are set. Contact us if you need assistance in determining or computing a normalized NWC for your industry.

Our team is always ready to help.

Please contact us for more information.

Margaret Amsden

Shareholder, Private Client Services

Contact Margaret   |   Read Margaret's bio

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Clayton & McKervey Announces New Stimulus Benefits Check-in Service

Clayton & McKervey, a certified public accounting and business advisory firm helping growth-driven companies compete in the global marketplace, has immersed itself into the inner workings of the latest COVID-19…

Read full story

Are Foreign-Owned or Controlled Companies Eligible for a PPP 2.0 Loan?

The persistence of the COVID-19 pandemic has created challenging business conditions in Michigan and across the U.S. The second wave of infections has forced many state and local government agencies…

Read full story

PPP Loan Round 2 – Should You Apply?

A new round of PPP loans (PPP2) was ushered in with the passage of the Economic Aid to Hard-Hit Small Businesses, Nonprofits and Venues Act (Economic Aid Act) on December…

Read full story

Understanding Transactions, Even if Your Business Isn’t for Sale

Selling your small business may not have been your focus in 2020 and may not be your focus in 2021. With an economy in flux and public health at the…

Read full story

State and Local Tax Planning: What You Need to Know

In a world that is becoming more global, many companies have focused their resources on dealing with new international markets. While important, it is also imperative businesses do not take…

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Read news direct from our managers and stakeholders.

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  • Beth Butchart
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  • Ruben Ramirez
  • Sarah Russell
  • Sue Tuson
  • Tarah Ablett
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  • Tim Finerty
  • Tim Hilligoss
  • Wendy Reedy

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