How do institutional buyers calculate working capital targets during an acquisition, and how do we optimize our balance sheet years before going to market?

Question

Tyler Smith · Accepted Answer

Working capital negotiations are a primary mechanism buyers use to effectively reduce the purchase price just before closing. Buyers acquire a business expecting sufficient liquidity, inventory, and receivables to run normal operations without injecting additional capital. They calculate a working capital peg based on your historical monthly averages, usually over the trailing twelve months.

If your balance sheet is poorly managed, displaying erratic swings in accounts receivable, bloated inventory, or delayed accounts payable, the buyer will set a conservative, artificially high working capital target. If your delivered working capital at closing falls short of that peg, the difference is deducted dollar-for-dollar from your purchase proceeds.

Optimizing your balance sheet requires disciplined operational habits established years in advance. Use your weekly Scorecard to track Days Sales Outstanding (DSO), billing cycle velocity, and inventory turns. Enforce strict customer credit terms, automate collections notices, and liquidate stale inventory rather than letting it sit on your books.

Creating a clean, predictable working capital profile over a multi-year exit runway eliminates balance sheet volatility. When acquirers conduct their Quality of Earnings audit, a stable cash conversion cycle prevents aggressive working capital adjustments, ensuring the gross price negotiated in the letter of intent matches the cash wired at closing.