What Is Normalised Working Capital In Transactions

Gregor Steedman, author of blog about working capital in transactions

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Working Capital is generally one of the key considerations in an M&A transaction. It is often a subjective and complex area, and it can have implications on the total consideration payable in a transaction.

What does working capital represent?

Net Working Capital is broadly defined as the current assets of a company, minus current liabilities. Key components typically consist of Accounts Receivable, Stock/Work in Progress, Accounts Payable and Payroll Liabilities.

It is a measure of liquidity generated through the Company’s trading, and its ability to meet short-term obligations, as well as fund operations of the business.


In a typical transaction, a Buyer and Seller (with assistance from their respective advisers) will agree on an Enterprise Valuation of the target business. Enterprise Value can be arrived at by utilising various valuation methodologies, but the most common approach is to apply a multiple to the target company’s Maintainable EBITDA/Earnings.

The Enterprise Value is what the business is worth on a cash-free, debt-free basis (i.e. before any adjustments are made for surplus cash and outstanding debt), and assuming a normalised level of Working Capital.

It is implicit in an earnings-based valuation that the target company will have sufficient working capital at completion of the transaction to maintain such level of earnings, without any immediate liquidity issues. The difficulty comes in determining what is a ‘sufficient’ level of net Working Capital…


Working Capital is generally addressed at the outset of a transaction. The Heads of Terms usually specify the purchase price, with it noted that this is subject to a normalised level of Working Capital at completion (a normalised Working Capital ‘Target’ is established as part of the financial due diligence).

If the net Working Capital at completion of the transaction is higher than the ‘Target’, the buyer often pays the seller an incremental amount, pound-for-pound, which effectively increases the purchase price. Vice versa, if the completion net Working Capital is below the ‘Target’ then the price may be adjusted downwards. It is therefore in the Buyer’s interest for the ‘Target’ to be as high as possible, whereas the Seller will want this to be as low as possible (to give them the best chance at delivering Working Capital above the ‘Target’ at completion, and therefore increasing their proceeds!).

The ’Target’ normalised Working Capital also safeguards both the Buyer and the Seller from any one-off Working Capital movements or trends in the run up to completion, for example:

  • If, in the run up to completion of the transaction, a large customer who typically pays within 60 days suddenly pays an invoice early, the Company’s cash balance will have increased. As the deal is Cash-free, Debt-free, the Seller’s proceeds will be increased by the Cash, however the Buyer will be left with a Trade Receivables balance which is below ‘normal’ levels (normal levels would have been 60 days). This scenario would be caught by the ‘Target’ Working Capital, as the company’s Working Capital at completion is likely to be lower than the ‘normalised’ (Target) levels, and an adjustment would be made accordingly to the purchase price.
  • Similarly, it removes the temptation for Sellers to restrict the payment of creditors, in order to improve the cash balance of the business on completion, as the actual Working Capital at the completion date will be correspondingly lower, and therefore see a reduction to the purchase price when measured against the ‘Target’ Working Capital.


Exactly what the normalised Working Capital is for any target company is subject to financial due diligence, and generally a negotiation between the buyer and the seller. Unhelpfully, there is no standard definition on how to calculate a normalised Working Capital ‘Target’, therefore it is normally a key negotiation during a transaction between a buyer and seller and their respective advisors, and can lead to potential value gain / loss for either party should the ‘Target’ not be set at an appropriate level.

A typical process for establishing this would include:

  • Establishing which elements of the balance sheet relate to Cash and Debt-like items:

    • This process may sound easy, but there are often various components which are complex and negotiated on. For example, deferred income – when cash has been received from a customer for a service/product which has not been delivered yet. It can be argued either way whether this is a debt-like item, or a working capital item – deferred income included in working capital is more beneficial to the seller, whereas if it is defined as a debt-like item, it is more beneficial to the buyer, therefore this can often direct the negotiation position for each party.
  • Establishing which items relate to Working Capital:

    • Review of the average Working Capital levels within the business, to assess the normal Working Capital removing any peaks or troughs due to seasonality. Typically, this is measured over the last 12 months, however for growing businesses the calculation may be based on a number of actual months and forecast months (for example the average over the most recent six months actual Working Capital and the next six months forecasted Working Capital) or indeed entirely based on a future period if the Enterprise Value is calculated based on the future performance of the target company;
    • The Buyer (and Seller) will prepare a net working capital analysis as part of the financial due diligence. This review will typically include consideration of Working Capital trends (e.g. seasonality) and any one-off large movements in certain Working Capital items. For instance, adjustments may be proposed for the following areas, in order to arrive at a ‘normalised’ level of Working Capital:
      • Adjustments for slow moving or obsolete stock.
      • Adjustments for significantly aged receivables or payables (outwith a ‘normal’ cycle or payment terms of the business).Adjustments for one-off items – such as large creditors relating to capital expenditure, or working capital items relating to one-off projects.
      • Adjustments to reflect differences between month-end and year-end accounts (to ensure comparing like with like when it comes to the completion accounts)


Once the transaction has been concluded, there is typically a set of Completion Accounts prepared. This will determine the level of Completion Cash and Debt, as well as Completion Net Working Capital – which is then compared against the ‘Target’ Working Capital.

Under a Locked Box completion mechanism, this adjustment will have been agreed as at a date before completion, which will result in a known adjustment to the purchase price having been made, however, the same principles noted above will still apply.

If the net Working Capital at completion of the transaction (or as at the Locked Box date) is higher than the ‘Target’, the purchase price is increased by the incremental amount, pound-for-pound. Vice versa, if the completion net Working Capital is below the ‘Target’ then the price may be adjusted downwards.

It is vitally important that both buyers and sellers undertake a thorough assessment of Net Working Capital, in order to ensure that a sufficient Working Capital ‘Target’ is set. We would always advise parties entering into a potential M&A process to engage with Corporate Finance experts in advance of negotiations on Working Capital. The AAB Corporate Finance Team has extensive experience in supporting both buyers and sellers throughout this process, achieving significant value for our clients in the process.

If you have any queries about normalised working capital or if you need any support no matter the stage of your business journey, please do not hesitate to contact Gregor Steedman, or any member of our Corporate Finance Team.

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