Working capital, explained
- kamfaulkner
- Sep 24
- 4 min read
When you sell or buy a business, one of the most important, but often overlooked, concepts is working capital. Get it wrong, and the agreed price can shift dramatically at completion.
This article unpacks what working capital is, what “normalised” working capital means, and how it ties into completion accounts when a deal closes.
What is working capital?
In plain terms, working capital is the cash the business needs to keep the wheels turning day to day. It’s usually calculated as:
Current assets - current liabilities
Current assets typically include trade debtors (customers who owe the business money), stock/inventory, and prepayments.
Current liabilities typically include trade creditors (suppliers the business owes), accruals, and short-term liabilities due within 12 months.
A positive working capital balance shows the business can cover its short-term commitments. Negative working capital suggests the company may struggle without fresh funding.
Why does it matter in a business sale?
Buyers want to take over a business that can run smoothly from day one, without needing an unexpected cash injection. Sellers, on the other hand, don’t want to be penalised for running their business efficiently (for example, by keeping stock levels lean or collecting debtors quickly).
That’s why working capital is nearly always part of the price adjustment when you sell or buy a company. It ensures the buyer gets what they paid for, and the seller receives fair value for the business they’ve built.
What is “normalised” working capital?
The key word is “normalised”. This means adjusting the working capital figure so it reflects a sustainable, business-as-usual level, rather than a figure distorted by timing quirks or unusual events.
For example:
A seller might delay paying suppliers just before completion to make the business look “cash rich”.
Seasonal swings can inflate or reduce stock and debtors at certain times of year.
Exceptional one-off payments (like settling litigation) can distort the picture.
Normalisation strips these out, giving both sides a fair benchmark of what working capital should be at completion.
How is the benchmark agreed?
Analysis of past accounts: Typically, accountants will look at 12–24 months of trading to establish the average working capital required.
Seasonality checks: If the business is seasonal (e.g. retail, agriculture), the benchmark may be based on the same point in the prior year.
Adjustments for unusual items: Non-recurring or exceptional costs and income are removed so the benchmark reflects “steady state” trading.
This agreed level is called the Target (or Normalised) Working Capital. At completion, the actual working capital is compared to this target.
If the actual figure is higher, the buyer usually pays more (the seller is compensated for leaving more resources in the business).
If it’s lower, the buyer pays less, as they’ll need to inject extra funds.
Where do completion accounts come in?
Completion accounts are the financial snapshot taken at the moment the deal closes. They confirm the actual levels of cash, debt, and working capital in the business.
Here’s how the mechanism works:
This is often described as a cash-free, debt-free, normalised working capital deal. The idea is to separate the value of the business itself (enterprise value) from the fluctuating balance sheet items.
Find out more here:
A simple example
Enterprise value agreed: £5m
Target working capital: £500k
At completion, the accounts show actual working capital: £350k
Because the actual is £150k below the target, the purchase price is reduced to £4.85m. Without this adjustment, the buyer would have inherited a shortfall and had to inject extra money immediately.
Key takeaways for sellers and buyers
For sellers
Be prepared to justify what “normal” working capital looks like for your business.
Expect scrutiny of your debtor collection and creditor payment practices.
Avoid “window dressing” – buyers will spot it, and it may sour negotiations.
For buyers
Insist on a robust completion accounts mechanism.
Watch for seasonal swings or unusual items.
Ensure the sale and purchase agreement) defines working capital clearly to avoid disputes.
Summary
Working capital is more than an accounting formula, it directly affects the cash you receive or pay on a business sale. Normalising working capital ensures neither party is short-changed, while completion accounts provide the final, agreed adjustment.
Handled carefully, these tools give both sides clarity and fairness. Handled badly, they can lead to costly disputes.
If you’re preparing to sell or buy a business, it’s worth getting expert advice early to understand your position and avoid surprises.
Next step
Talk through your situation with our team:
📩 info@orbitlegal.co.uk | 📞 0115 6777095 |
Disclaimer
This content is for general information only and doesn’t constitute legal, accounting, financial, or tax advice. It’s based on the law of England & Wales and was correct at the date of publication, but the law and guidance can change. Reading this page doesn’t create a solicitor–client relationship with Orbit Legal. Please take advice on your specific circumstances before acting. Get advice for your situation by contacting Orbit Legal at info@orbitlegal.co.uk or 0115 6777095.
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