Many owners focus on headline price when they think about selling a business. Price matters, but it is not the only number that determines what you take home at closing. Working capital is one of the most common places where sellers are surprised, negotiations get tense, and closing gets delayed.
This article is educational and general in nature. It is not legal, tax, or financial advice. Every business and transaction is different, so use this as a framework and review your specific situation with qualified professionals.
What Working Capital Means In Plain English
Working capital is the cash tied up in running the business day to day. In most deals, it is calculated as:
- Current assets (such as accounts receivable, inventory, and prepaid expenses)
- Minus current liabilities (such as accounts payable, accrued expenses, and certain short-term obligations)
Think of working capital as the fuel that lets the company keep operating after the seller steps away. A buyer generally expects to receive a business that can open its doors the next morning, serve customers, and pay bills on normal terms without immediately injecting cash.
That expectation becomes a negotiation point because “normal” depends on the business. A seasonal distributor, a project-based service company, and a light manufacturing shop can have very different working capital profiles, even if their annual profit looks similar.
Why Working Capital Can Change Your Net Proceeds
In many small business sales, the purchase price is stated as a fixed number, but the agreement includes a working capital target. If the actual working capital delivered at closing is below the target, the purchase price is usually reduced dollar for dollar. If it is above the target, the purchase price may increase, depending on the deal.
This is why working capital is not a technical footnote. It can move the economics of the transaction in a very real way.
For sellers in the Spokane area and across the Inland Northwest, this can be especially relevant because many companies are owner-operated and optimized for tax efficiency or cash management. Those choices can be reasonable while you own the business, but they can create mismatches when a buyer underwrites “run rate” operations.
How Buyers Usually Set A Working Capital Target
There is not one universal method, but buyers commonly use a practical approach based on historical averages and operating needs.
Average Over A Lookback Period
A buyer may analyze monthly working capital over a defined period, often 12 months, and propose a target based on an average. The idea is to reduce the chance that the number is distorted by one unusual month.
However, averages can still be misleading if the business has seasonality or large projects. In that case, a buyer may use a seasonal method, such as setting a target that reflects the expected working capital level for the month of closing or for the peak operating months.
Normalized Level Needed To Operate
Some buyers set a target based on what it takes to operate responsibly. For example:
- If customers typically pay in 45 days, accounts receivable will be part of the normal working capital need.
- If inventory is required to fulfill orders on time, inventory levels must be realistic, not artificially low.
- If payables are stretched beyond normal terms, a buyer may view the current liability balance as a short-term risk and adjust the target.
This is one area where an operator-minded buyer can be a better fit than a purely financial buyer. A buyer who plans to Buy. Grow. Operate. tends to care about a stable operating handoff, not just a spreadsheet outcome.
What Typically Counts As Working Capital In A Sale
Working capital definitions are negotiated. The purchase agreement should define what accounts are included and excluded, and how they are measured. Below are common items, but your deal may treat them differently.
Accounts Receivable
Receivables are often included, but buyers may discount old or doubtful receivables. Expect questions like:
- How old are the receivables?
- Are there any disputes or credits pending?
- Is the aging consistent with the business history?
If receivables spike before closing due to billing timing, a buyer may want to confirm the work was actually performed and that collections are likely.
Inventory
Inventory is often included, but only at an agreed valuation method. Buyers may scrutinize:
- Obsolete or slow-moving items
- Inventory accuracy and cycle counts
- Whether inventory is valued consistently (cost method)
If the business carries more inventory than needed, that can inflate working capital and lead to disagreement. If it carries too little, the buyer may need to invest cash after closing and will argue that the seller did not deliver a normal operating level.
Prepaid Expenses
Prepaids like insurance or rent can be included, but sometimes they are excluded because they can feel like a double payment to the buyer. A clear definition prevents last-minute disputes.
Accounts Payable And Accrued Expenses
Payables and accruals are usually included on the liability side, but buyers often test whether they reflect normal operations. If you have been paying vendors slowly, a buyer may adjust the target or add a special treatment for payables that are beyond typical terms.
Accrued payroll, bonuses, and vacation can also be contentious. Some deals treat certain accruals as a seller responsibility; others include them in working capital. The key is clarity, and that clarity needs to show up before the final week of the transaction.
Common Working Capital Problems That Create Closing Surprises
Seasonality And Timing Games
Even honest businesses can unintentionally distort working capital due to timing. A large customer payment that lands one day after month end can make receivables appear higher. A big vendor payment made early can make payables appear lower. Buyers know this, and they will often ask for daily cash and working capital snapshots as closing approaches.
The safest approach is to run the business normally. If you attempt to manage working capital purely to maximize the closing adjustment, it can backfire. It can also erode buyer trust at the exact moment you want the process to be smooth.
Owner Related Expenses Buried In Current Accounts
Owner-operated businesses sometimes run personal items through the business or use the business as the central cash management hub. In diligence, buyers may find items in receivables, payables, or accruals that should be reclassified. Reclassifications can change working capital and can create friction if they surface late.
Unclear Customer Deposits And Deferred Revenue
Customer deposits are a frequent pain point. A deposit can look like cash on the balance sheet, but it also represents an obligation to deliver future work. Buyers may treat deposits as a current liability that reduces working capital, especially if the company must perform work before recognizing revenue.
If your bookkeeping does not track deposits consistently, expect extra attention here.
Inventory That Does Not Match Reality
In some small companies, inventory tracking is more habit than system. That can be workable when the owner knows what is on the shelves. During a sale, it becomes harder. If the records do not match reality, buyers can push for an inventory count, write-downs, or special escrow provisions.
Accounts Payable That Are Artificially Low Or High
If you have been paying vendors unusually fast, your payables might be low, which increases working capital and might look good for the seller. But it can also be non-normal. If you have been stretching vendors, payables might be high, which reduces working capital and can look like a surprise clawback at closing. Either way, buyers tend to normalize to typical terms.
How To Prepare For Working Capital Discussions Before You Go To Market
You do not need a perfect accounting department to sell a business. You do need a clear picture of how the company funds operations, and you need books that can stand up to buyer questions.
Clean Up The Balance Sheet
Owners often invest in the profit and loss statement and ignore the balance sheet. In a sale, the balance sheet matters. Before you start a process, work with your bookkeeper or CPA to:
- Reconcile bank, credit card, and loan accounts monthly
- Review accounts receivable aging and write off truly uncollectible balances
- Ensure payables are current and coded consistently
- Identify old accruals that should be cleared or explained
- Track customer deposits consistently
When the balance sheet is clean, working capital becomes a discussion about operations, not a debate about accounting.
Understand Your Normal Cash Conversion Cycle
A buyer will implicitly underwrite how quickly cash moves through your business. That includes:
- How fast customers pay you
- How long you hold inventory
- How quickly you pay vendors
If you can explain these drivers in simple terms, you will reduce friction. If you cannot, the buyer will assume risk and protect themselves through deal structure.
Document Seasonality
If your working capital swings by season, be proactive. Build a simple schedule showing monthly revenue, gross margin, receivables, inventory, and payables. A buyer can still set a fair target, but they need to see the pattern. Without it, you may end up with a one-size-fits-all target that is unfair in your closing month.
Decide What Is Not Part Of Working Capital
Many deals exclude cash and debt from working capital because they are handled separately in the purchase price or as closing adjustments. Some deals also exclude certain one-time items, related-party balances, or unusual accruals. There is no one right answer, but there is a wrong answer: leaving these decisions until the purchase agreement is being finalized.
What To Watch For In The LOI And Purchase Agreement
Working capital can be addressed in a few places, but it should not be a surprise clause in the final documents. Here are the practical points to look for.
Clear Definition Of Included Accounts
The agreement should specify which balance sheet accounts are included and how they are calculated. It should address whether the calculation is based on GAAP, tax basis, or a consistent historical method. Many small businesses do not run full GAAP financials; that is fine, but consistency should be defined.
Target Method And Lookback
The LOI should state how the target will be set, even if it is a preliminary target. If the LOI is silent, you risk spending time and money only to learn later that the buyer expects a working capital peg that you did not plan for.
Closing Statement And Dispute Process
Most deals include a post-closing true-up, where the parties finalize working capital based on a closing balance sheet. The agreement should define:
- Who prepares the closing statement
- When it must be delivered
- How disputes are resolved
- Whether an independent accountant is used
Without a defined process, a small disagreement can drag on for months.
How XIT Thinks About Working Capital As A Long Term Buyer
At XIT Investments, our posture is Buy. Grow. Operate. We buy businesses to hold and run long-term, not to flip and not as private equity. Working capital is not a trick or a lever for us. It is a practical part of ensuring the company can operate normally after closing, serve customers, and take care of the team.
If you are considering selling and want to talk through how working capital, deal structure, and diligence typically work for owner-operated companies in the Inland Northwest, we are happy to have a confidential conversation. You can learn more here: selling your business or reach out through our confidential contact page.
For additional background on what buyers tend to request during diligence, you may also find this helpful: Quality of earnings for a small business sale.
