Working Capital and Net Debt

Overview

In most acquisitions the price agreed is for a business delivered with a normal level of working capital and free of debt. The difference between the headline price and the amount finally paid is determined by two things: how much working capital is delivered compared with the agreed target, and which items are treated as net debt.

These definitions are frequently negotiated late and can move value by amounts comparable to the price discussion itself. We analyse both areas in detail and help you set definitions and targets that reflect how the business really operates.

What the service covers

The work addresses the two sides of the price adjustment mechanism, and the contract language that governs them:

• Net working capital: trade receivables, inventory, trade payables, accruals, prepayments and deferred income, defined consistently with the accounting policies in use.
• Normalisation: removing one-off, non-trading or out-of-period items from the working capital balances.
• Seasonality and trends: monthly balances over a sufficient period to establish a normal level or target.
• Net debt: bank borrowings, shareholder loans, accrued interest, cash and cash equivalents, including cash that is restricted or not freely available.
• Debt-like items: for example lease liabilities, deferred consideration, unpaid tax, pension and employee-related obligations, customer deposits, capital expenditure creditors, declared dividends and transaction costs.
• Cash-like items and the treatment of cash held within the group.
• The deal mechanism, whether completion accounts or a locked box, and the protections that go with it.

Key activities and deliverables

Key activities

• Build monthly working capital schedules from the ledgers and reconcile them to the balance sheet.
• Investigate unusual movements and review ageing, provisioning and cut-off for receivables, inventory and payables.
• Analyse the average and the trend in working capital to propose a normalised level or target.
• Compile a comprehensive list of debt and debt-like items, identifying those that appear in the accounts and those that do not.
• Quantify each item and recommend its treatment, with the supporting rationale.
• Review and comment on the relevant purchase agreement provisions and the specimen completion accounts.

Deliverables

• A working capital analysis with a recommended target and the reasoning behind it.
• A net debt and debt-like items schedule with a proposed treatment for each.
• Input on the definitions and accounting principles in the purchase agreement.
• An illustrative completion statement showing how the mechanism would operate.
• Where engaged post-deal, support with preparing or reviewing completion accounts and resolving disputes.

Our approach and methodology

We define working capital in a way that matches the way the business is managed, then test the definition against the accounting policies, so that completion accounts can be prepared consistently with the target. The proposed level is based on a period long enough to capture seasonal and cyclical swings, and we explain where recent trading means history is not a reliable guide.

For net debt, we take a wide view of what a buyer or seller could reasonably regard as a claim on value, then agree a specific treatment for each item. Clear definitions reduce the scope for disagreement, and an agreed illustrative calculation makes the mechanism easier to apply on completion.

Benefits for clients

• A fair working capital target that neither overcompensates nor penalises either party.
• No late surprises on debt-like items that reduce price.
• Clear, specific definitions that reduce the chance of post-completion disputes.
• A better understanding of the cash the business needs to operate and grow.
• Informed negotiating positions, whether you are buying or selling.

Who needs this service

This service is relevant to anyone who has to agree or defend a price adjustment, including:

• Buyers and sellers negotiating a completion accounts or locked box mechanism.
• Private equity sponsors and corporates on either side of a transaction.
• Legal advisers who need financial input on definitions in the sale and purchase agreement.
• Finance directors preparing or reviewing completion accounts.
• Lenders who want to understand the liquidity a business needs in its operating cycle.