What counts as working capital in a business sale?
Working capital is the operating current assets a buyer needs to run the company on day one, minus the operating current liabilities that come due in the normal course. In most written purchase agreements the definition is spelled out line by line, so the accounts you include matter more than the formula.
The lines that normally go in:
- Assets: accounts receivable, inventory, prepaid expenses, and deposits tied to operations.
- Liabilities: accounts payable, accrued payroll and vacation, customer deposits, and deferred revenue.
The lines that normally stay out: cash, which you keep in a cash-free, debt-free deal; loans and lines of credit, which are paid off from proceeds; owner loans; and income taxes. Working capital is a balance sheet measure. It has nothing to do with seller discretionary earnings, which measure income. The purchase price already assumes you deliver a normal level of working capital, so the peg protects the buyer from you draining it before closing.
Before you sign an LOI, ask for the buyer's proposed working capital definition in writing and compare it line by line against your own monthly balance sheet.
How do you calculate working capital and the peg, step by step?
You add up the included current assets, subtract the included current liabilities, and repeat that for each month in a look-back period; the peg is the average of those monthly results, adjusted for seasonality and one-time items.
Take a company with $1,000,000 in revenue and $250,000 in SDE. The balance sheet figures below are round illustrative inputs. The SDE does not enter the calculation.
| Line | Peg month | Closing |
|---|---|---|
| Accounts receivable | $90,000 | $75,000 |
| Prepaid expenses | $10,000 | $10,000 |
| Current assets | $100,000 | $85,000 |
| Accounts payable | $40,000 | $40,000 |
| Accrued payroll | $20,000 | $20,000 |
| Current liabilities | $60,000 | $60,000 |
| Working capital | $40,000 | $25,000 |
The peg column is the arithmetic of $100,000 minus $60,000, which gives a $40,000 target. In practice you average several monthly balance sheets rather than one month. Seasonal businesses need the look-back to cover a full cycle, or the peg will be set off a high or low point.
Know your own monthly numbers before the buyer's accountant calculates them for you, because the buyer will propose the peg that favors the buyer.
What happens if working capital at closing is different from the peg?
The price adjusts dollar for dollar. If closing working capital is below the peg, the price drops by the shortfall; if it is above, the buyer pays you the excess.
In the example, closing working capital is $25,000 against a $40,000 peg, so the price falls by $15,000 ($40,000 minus $25,000). The drop came from receivables falling from $90,000 to $75,000, for instance because you collected aggressively and kept the cash, or because slower billing left invoices unissued. Either way, the buyer inherits a business that carries $15,000 less in receivables than the price assumed.
Closing figures are estimates. The buyer prepares a closing statement after closing, you get a review window, and disputes go to an independent accountant under the purchase agreement. Three terms decide how much that process costs you:
- Whether the accounting policies match how you have always kept the books.
- Whether there is a collar, a band around the peg inside which no adjustment applies.
- Whether any shortfall is paid from an escrow or by you directly.
How the peg is set and negotiated in more depth is covered in the working capital peg guide. In an asset sale the receivables and payables transfer only if the contract says so, which affects what sits inside the calculation, as explained in asset sale vs stock sale.
Ask your advisor to run your closing-month balance sheet against the proposed peg before the LOI is signed, so you see the $15,000 type of surprise while the term is still negotiable.
Frequently asked questions
Is cash included in working capital when I sell my business?+
In a cash-free, debt-free deal, cash is excluded and stays with you, and the buyer pays off debt from proceeds. If cash is left in the company, it should be a separate line in the price. Check that the definition does not quietly pull restricted cash or customer deposits into your side of the calculation.
Does the buyer pay extra if I leave more working capital than the peg?+
Yes, if the agreement is written as a two-way adjustment. Some buyers draft it so only shortfalls reduce the price, which gives you no credit for a surplus. Confirm the adjustment runs both directions at LOI.
Can I take the receivables and leave the payables?+
Only if the contract says so, and then the peg must be set on the same basis. If you keep the receivables, the buyer will expect a much lower target or a price cut. Mixing the two approaches is a common source of disputes over the closing statement.
Who prepares the closing working capital statement?+
The buyer usually drafts it after closing from the closing-date books, and you get a set review period to object. Unresolved items go to an independent accountant named in the agreement. Your best protection is an accounting policies schedule attached to the purchase agreement.