Working capital and cash conversion

Working capital is current assets minus current liabilities. The peg is the normal level required to operate. You calculate it from 12 months of balance sheets, then finalize it for the purchase agreement.

• Step 1: Pull 12 months of month-end balance sheets You need monthly snapshots, not just year-end. For each month calculate current assets (cash, receivables, inventory, prepaid expenses) minus current liabilities (payables, accrued expenses) to find net working capital. (Step 1)
• Step 2: Remove outlier months to adjust for seasonality Seasonality means predictable fluctuation in working capital driven by the business cycle - a landscaping company has high receivables in summer and low ones in winter. With 12 months of data, remove the two highest and two lowest months. W (Step 2)
• Step 3: Average the remaining months The result is your working capital peg. At close, actual working capital is compared to this number and the purchase price adjusts dollar-for-dollar. (Step 3)

• Pull 12 months of month-end balance sheets transforms Remove outlier months to adjust for seasonality: Step 1 naturally follows from the prior action.
• Remove outlier months to adjust for seasonality transforms Average the remaining months: Step 2 naturally follows from the prior action.

Decision gate for the three warning signs. Proceed when: Working capital is stable or growing and the peg calculation is reasonable.

• Reconsider: Working capital is declining. Reduce the peg to reflect actual funding needs, or add a covenant requiring the seller to
• Proceed: Working capital is stable or growing and the peg calculation is reasonable.
• Walk: Working capital has collapsed and indicates a cash crisis. The business may not be viable.
• Reconsider: Working capital is declining. Reduce the peg to reflect actual funding needs, or add a covenant requiring the seller to