Working Capital: The Hidden Number That Changes Your Check at Closing

Most sellers focus on the purchase price and forget about working capital until closing day. That is a mistake that can cost $100,000 or more. Here is how working capital works in a business sale and how to protect yourself.

You have negotiated a $3.8 million deal. The purchase agreement is signed. Closing day arrives. And the buyer tells you there is a working capital shortfall of $180,000, so your check is $3.62 million. For most sellers, this is the first time they have seriously thought about working capital. It should not be. Working capital adjustments are one of the most frequently misunderstood, and most frequently disputed, elements of a service-business sale.

What Working Capital Actually Is

Working capital is the difference between current assets and current liabilities. In a service business, current assets are primarily accounts receivable, cash left in the business, and inventory or parts on hand. Current liabilities are accounts payable, accrued expenses (like wages owed but not yet paid), and any deferred revenue from prepaid service agreements.

Working Capital = Current Assets minus Current Liabilities. In a service business sale, the buyer expects you to leave behind enough working capital to run the business from day one without injecting new cash.

The principle is simple: when you sell a business, the buyer is acquiring an ongoing operation. They should not have to immediately fund payroll, pay suppliers, and collect receivables from scratch. The expectation is that the business comes with a normal level of working capital already in place, sometimes called the peg or the target working capital.

How the Working Capital Peg Works

During negotiations, the buyer and seller agree on a target working capital amount, usually based on a trailing 12-month average. If the business delivers more working capital than the target at closing, the seller gets an increase in the purchase price. If the business delivers less, the seller gets a decrease. The adjustment is dollar for dollar.

For a residential HVAC business doing $4 million in revenue, a normal working capital target might be $300,000 to $450,000. How that number is defined, including which accounts are included, how receivables over 90 days are treated, and whether deferred revenue counts, is negotiated in the purchase agreement. Every definition decision moves the final check.

The Most Common Working Capital Surprises for Sellers

Draining Cash Before Closing

The most common mistake sellers make is pulling cash out of the business in the months before closing. A bonus, a distribution, an equipment purchase, or simply not collecting receivables as aggressively, all of these reduce the working capital delivered at closing and reduce your check by the same amount.

Deferred Revenue from Maintenance Agreements

If customers prepay for annual maintenance agreements, that cash is on your balance sheet as a liability (deferred revenue) because you have not yet performed the service. Buyers will count that liability against your working capital. A business with 500 maintenance agreements at $200 each could have $100,000 in deferred revenue on the books at any given time. That reduces working capital by $100,000 unless you negotiate how it is treated.

Aged Receivables

Buyers typically exclude receivables over 60 or 90 days old from the working capital calculation, treating them as uncollectible. If you have been slow to follow up on overdue invoices, those aged receivables will reduce your working capital and your final check. In the three to six months before closing, actively collect any receivable over 45 days. It is real money.

Negotiating the Working Capital Definition

The working capital peg is negotiated, not handed down from the sky. Here is where sellers leave value on the table by treating it as a standard term rather than a negotiable one.

• Push for a normalized peg based on a 12-month average, not a peak period that inflates the target
• Negotiate the treatment of cash, since some buyers want cash excluded entirely while it often belongs to the seller
• Address how deferred revenue from prepaid agreements is handled, including whether it is excluded or offset
• Confirm how receivables aging will be determined and at what threshold they are excluded
• Set a clear measurement date, typically two to three days before closing, to avoid disputes

Cash: Often Excluded, Often Misunderstood

In most transactions, the seller retains the cash in the business as of closing. Cash is typically excluded from both the working capital calculation and the purchase price, because it is considered a distribution to the seller pre-close. However, some buyers try to include cash in the working capital target to force you to leave more money behind. Understand what your purchase agreement says about cash, and make sure your M&A attorney reviews it before you sign.

A Real-World Example

A roofing business sells for $2.8 million. The agreed working capital target is $280,000. At closing, the measured working capital is $210,000, meaning $70,000 below the peg. The seller's check at closing is $2.73 million, not $2.8 million. The seller thought they were fine because the business had plenty of cash, but they had not collected $85,000 in receivables over 90 days, which the buyer excluded from the calculation. Collecting those receivables before closing would have put the seller within range of the target.

Working Capital and Your Closing Day Checklist

• Do not take unusual distributions or bonuses in the 90 days before closing
• Aggressively collect any receivables over 45 days while you still control the business
• Understand the exact working capital definition in your purchase agreement
• Monitor working capital monthly in the six months before your target close date
• Have your accountant project the working capital delivery two weeks before the measurement date

Working capital rarely gets the attention it deserves until closing day, and by then it is too late to fix. Understanding it early is straightforward and the payoff can be six figures. Run a free Exit Lab valuation to get a complete picture of your business's financial health, including the metrics that matter most in a sale.