Working Capital Analysis for M&A Due Diligence
Published February 2026
Working capital is the cash engine of a business. Getting the peg wrong means you're either overpaying at close or underfunding the business post-acquisition.
12–24 mo
Typical NWC peg lookback period
DSO + DIO − DPO
Cash conversion cycle formula
#1
Most negotiated QoE line item
What Is Net Working Capital?
Net working capital (NWC) is the difference between a company's current operating assets and current operating liabilities. It represents the capital required to fund day-to-day operations.
In M&A, NWC excludes cash, debt, and debt-like items — it focuses on the operating cycle: accounts receivable, inventory, prepaid expenses, accounts payable, accrued liabilities, and deferred revenue.
Why Working Capital Matters in M&A
Purchase price adjustment
Most deals include a working capital mechanism — the purchase price adjusts if NWC at close differs from the agreed peg
Cash at close
A buyer who underestimates NWC needs may face a cash crunch immediately post-acquisition
Manipulation risk
Sellers can inflate NWC pre-close by delaying AP payments or accelerating AR collections
Seasonal businesses
NWC swings dramatically in seasonal businesses — the peg methodology matters significantly
Working Capital Peg Calculation
The working capital peg (or target) is the normalized level of NWC the seller agrees to deliver at closing. If actual NWC at close exceeds the peg, the buyer pays the surplus. If it falls short, the purchase price is reduced dollar-for-dollar.
Trailing average
Most common method — average NWC over the trailing 12 or 24 months
Median approach
Uses median rather than mean to reduce the impact of outlier months
Normalized approach
Adjusts individual components for known anomalies before averaging
Collar mechanism
Some deals use a collar (e.g., ±$50K) where small deviations don't trigger adjustments
Key Components of NWC
Accounts receivable
Amounts owed by customers — review aging, concentration, and bad debt reserves
Inventory
Raw materials, WIP, and finished goods — watch for obsolescence and slow-moving items
Prepaid expenses
Insurance, rent, and other prepayments — ensure they reflect normal operating levels
Accounts payable
Amounts owed to suppliers — verify payment terms are maintained at historical levels
Accrued liabilities
Wages, taxes, and other accruals — confirm they're adequate and consistently applied
Deferred revenue
Prepayments from customers for future services — a current liability that reduces NWC
Turnover Ratios & Cash Conversion
Turnover ratios reveal how efficiently the business converts working capital into cash:
Days Sales Outstanding (DSO)
AR ÷ Revenue × 365 — how quickly customers pay. Rising DSO signals collection issues
Days Inventory Outstanding (DIO)
Inventory ÷ COGS × 365 — how long inventory sits. Rising DIO may indicate obsolescence
Days Payable Outstanding (DPO)
AP ÷ COGS × 365 — how slowly the company pays suppliers. Falling DPO may indicate strained vendor relationships
Cash Conversion Cycle
DSO + DIO − DPO — the total days from cash out to cash in. Lower is better
Seasonality Adjustments
Seasonal businesses require special attention in NWC analysis. A landscaping company's NWC in January looks very different from July. Using a simple trailing average without adjusting for seasonality produces a misleading peg.
Monthly NWC mapping
Chart NWC by month to visualize seasonal patterns
Same-month comparison
Compare each month to the same month in prior years
Close date awareness
If closing in a high-NWC month, a trailing average peg may be unfair to the seller
Normalized peg
Some deals use a seasonally-adjusted peg formula rather than a fixed dollar amount
Working Capital Analysis Process
Define included accounts
Agree on which balance sheet accounts are in vs out of NWC (exclude cash, debt, tax-related)
Build monthly NWC schedule
Calculate NWC for each month in the analysis period (typically 24 months)
Identify anomalies
Flag months with unusual spikes or dips — investigate root causes
Normalize components
Adjust individual line items for known one-time events
Calculate the peg
Apply the agreed methodology (trailing average, median, normalized)
Analyze turnover trends
Review DSO, DIO, DPO trends for signs of manipulation or deterioration
Assess seasonality
Determine if seasonal adjustments are needed based on the closing timeline