We have historically run our business on a cash basis for tax purposes, but the buyer is insisting on a GAAP-compliant net working capital peg. How do we prevent this accounting conversion from artificially inflating our working capital target and leaving our cash trapped in the business?

Question

Tyler Smith · Accepted Answer

Converting from cash-basis to GAAP accounting during a transaction is a minefield that can cost you hundreds of thousands of dollars at the closing table. Because cash-basis accounting does not record accounts receivable or accounts payable until cash actually changes hands, a sudden shift to accrual-basis GAAP will suddenly show a massive amount of working capital that was previously unrecorded. If the buyer calculates your net working capital peg using this newly converted GAAP data without adjusting for historical patterns, they will set a target that is artificially high. This means you will be forced to leave extra cash in the business at close to meet that baseline. To prevent this, you must demand a consistent accounting methodology across both the historical period and the closing balance sheet. If the peg is going to be calculated on a GAAP basis, your historical monthly balance sheets for the last twelve months must be meticulously reconstructed using the exact same GAAP policies. This ensures an apples-to-apples comparison. Pay close attention to deferred revenue and accrued expenses. If you receive customer prepayments, these must be excluded from the net working capital calculation so they do not artificially bloat the target. Have your financial seat on the Accountability Chart run these parallel calculations early. Address this discrepancy head-on during your V/TO® alignment sessions so your negotiation team is fully prepared to defend your cash position before the definitive agreements are drafted.