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How do you calculate the change in net working capital?
A letter of intent mentions a normal level of working capital, or your sales grow while your cash shrinks. Here is the calculation, what it tells you, and how it reaches a sale price.
By Surfside Capital AdvisorsPublished Updated 4 min read
The change in net working capital is ending net working capital minus beginning net working capital, where net working capital is current assets minus current liabilities. An increase uses cash and a decrease releases it. In a sale, the same arithmetic checks that the business is handed over with the working capital the buyer priced in.
A letter of intent says the price assumes "a normal level of working capital," or your sales are growing while your cash is shrinking. Both come from the same place: money tied up in what customers owe you, what you hold in inventory, and what you owe suppliers.
What is net working capital?
Net working capital is what a business holds in current assets minus what it owes in current liabilities. The SEC's balance sheet rule, Rule 5-02 of Regulation S-X, names the usual items. On the asset side: cash, marketable securities, receivables, inventories, and prepaid expenses. On the liability side: accounts and notes payable, and other current liabilities such as accrued payroll, interest, and taxes, along with the current portion of long-term debt.
In a sale, working capital is usually measured without cash and debt, which are settled as separate items.
How do you calculate the change in net working capital?
Subtract net working capital at the start of the period from net working capital at the end. The figures below are an illustration, and they leave out cash and debt.
| Item | Start of year | End of year |
|---|---|---|
| Accounts receivable | $400,000 | $520,000 |
| Inventory | $300,000 | $380,000 |
| Prepaid expenses | $20,000 | $25,000 |
| Accounts payable | $250,000 | $290,000 |
| Accrued expenses | $90,000 | $110,000 |
| Net working capital | $380,000 | $525,000 |
The change is $525,000 minus $380,000, an increase of $145,000. The business used $145,000 of cash during the year, because it carried more receivables and inventory than suppliers and accruals financed.
What does the sign mean for cash?
An increase in net working capital uses cash, and a decrease releases it. That is why a cash flow statement subtracts an increase and adds a decrease.
Either direction can mislead. An increase can mean growth, or customers paying late and inventory piling up. A decrease can mean tighter collections, or suppliers being paid more slowly than the business can sustain.
How does working capital change the price in a sale?
Most purchase agreements set a target level of working capital and adjust the price after closing if the business is delivered above or below it. SRS Acquiom's 2026 study of private-target deals closed from 2020 through the third quarter of 2025 found a purchase price adjustment in 91% to 94% of deals in each year. In 2024 deals, 96% of post-closing adjustments rested on more than one measure, such as working capital, cash, and debt.
Most adjustments are small next to the price. The median final adjustment was 0.27% of transaction value when it favored the buyer and 0.17% when it favored the seller, and final adjustments favored the buyer in 51% of deals, the seller in 38%, and neither in 11%.
Because the target and the definitions decide the outcome, settle them before you sign a letter of intent. A target built from one strong month can hurt a seasonal business, so ask for one based on an average over a longer period. The accounting methods and the working capital definitions are written into the agreement, so check them line by line and test the target against your own monthly balances before you agree. The price you negotiate and the price you receive can differ for this reason, as how much should I sell my business for explains.
How can you manage working capital before a sale?
Keep it steady at a level the business can sustain, because a buyer measures the level you deliver at closing.
- Receivables: invoice promptly, and follow up on late payers.
- Inventory: hold what demand supports.
- Payables: pay on your normal terms.
Stretching supplier payments or running down inventory just before closing lowers working capital, and the adjustment can hand that difference back to the buyer.
What to do next
- Build a month-end net working capital history for the last 24 months, leaving out cash and debt.
- Find your normal level and your seasonal highs and lows.
- Note which accounts a buyer might treat differently, such as customer deposits, accrued bonuses, and unusual receivables.
- Read the working capital language in any letter of intent, and test the target against your last twelve months of balances, before you sign.
We help you build the monthly working capital history and a cash forecast, and prepare the materials a buyer asks for. That is part of our M&A advisory work.
Questions owners ask
Is negative working capital bad?
Not always. A business that collects cash before it delivers, such as one that bills subscriptions in advance, can run negative working capital by design. What matters is whether the level is steady, and whether the agreement's definition fits how your business works.
Is working capital the same as cash flow?
They are related, and they are different. Working capital is a balance at a point in time, and the change in it is one of the items that moves cash from one period to the next. How to improve cash flow for your business covers the rest.
General information, not legal, tax, or investment advice.
Sources
- 17 CFR 210.5-02, Balance sheets (Regulation S-X, Rule 5-02), U.S. Securities and Exchange Commission, via Cornell Legal Information Institute,
- 2026 M&A Working Capital Purchase Price Adjustment Study, SRS Acquiom,
Figures and rules as published by these sources on the dates shown.
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