Net Working Capital Analysis in Financial Due Diligence
How FDD analysts perform NWC analysis: defining normalised working capital, assessing seasonality, and setting the target for SPA negotiations.
Net Working Capital (NWC) analysis is one of the three pillars of any Financial Due Diligence, alongside the Quality of Earnings and the Net Debt review. Getting NWC right has a direct impact on the deal price — and misunderstanding it is one of the most common mistakes candidates make in TS interviews.
What Is Net Working Capital?
In an M&A context, NWC is typically defined as:
NWC = Trade Receivables + Inventories + Other Current Assets − Trade Payables − Other Current Liabilities
Note that cash, financial debt, and current tax items are usually excluded — they belong to the net debt calculation.
Why NWC Matters in M&A
When a business is sold, the buyer expects to receive a "normal" level of working capital alongside the business. If NWC is too low at closing, the buyer will need to inject additional cash to fund operations. If it is too high, the seller has effectively transferred excess value.
The NWC target — the level agreed in the Sale and Purchase Agreement (SPA) — is therefore a critical negotiation point. It is usually set as the average NWC over the last 12 to 24 months, adjusted for seasonality.
The FDD NWC Analysis in Practice
Step 1: Build the NWC History
The analyst builds a monthly or quarterly NWC schedule over the last two to three years. This reveals trends, seasonality, and anomalies.
Step 2: Normalise the NWC
Just like EBITDA is adjusted for one-off items, NWC is normalised to remove non-recurring movements:
- Unusually high or low debtor days at a specific point in time
- Stock build-ups ahead of a product launch
- Payment timing differences at period end
Step 3: Set the Target
The normalised NWC target is proposed by the FDD adviser, debated between buyers and sellers, and written into the SPA. Typical approaches:
- LTM average: Average of the last 12 months
- Specific reference date: NWC at the locked-box date
Step 4: Assess Risks
The analyst flags any working capital risks that could affect the buyer post-closing:
- Deteriorating debtor quality (rising days sales outstanding)
- Slow-moving or obsolete stock
- Vendor payments stretched beyond commercial terms
Common Mistakes in NWC Analysis
- Confusing NWC with cash flow: NWC is a balance sheet measure; free cash flow is a P&L-driven calculation.
- Ignoring seasonality: A business with strong Q4 revenue will naturally have high receivables at 31 December. The target must reflect this.
- Missing off-balance-sheet items: Factored receivables, reverse factoring arrangements, or supplier finance programmes can distort the picture significantly.
Conclusion
NWC analysis requires a blend of accounting knowledge, commercial judgment, and deal awareness. In TS interviews, expect detailed questions on how you would calculate, normalise and argue a working capital target.
The Transaction Services Interview Programme (€119.99, one-time) includes dedicated NWC modules with Excel models and SPA negotiation scenarios. Get access now.