Working Capital Analysis in Financial Due Diligence
How to analyse working capital in Financial Due Diligence: normalisation methodology, seasonality, NWC peg and impact on the transaction price.
Working capital analysis is one of the most practically complex parts of Financial Due Diligence. It's also one of the most frequently tested in Transaction Services interviews — because it directly affects the purchase price.
Why working capital matters in a transaction
When a buyer acquires a business, they expect to receive a "normal" level of working capital alongside the business. This normal level — the NWC peg — is contractually defined. If actual working capital at closing deviates from the peg, the price adjusts accordingly.
A seller with a low NWC at closing (because they ran down stock, stretched payables or accelerated collections) effectively delivers less than expected. The buyer will receive a price reduction. Conversely, higher-than-expected NWC leads to a price increase.
What working capital includes
Working capital in an FDD context is operating working capital:
NWC = Trade receivables + Inventories + Other operating assets – Trade payables – Other operating liabilities
Important exclusions: cash and short-term financial investments belong to net debt, not NWC. Current tax balances are typically excluded from the operating NWC calculation.
The normalisation methodology
The goal is to determine the sustainable, representative level of NWC for the business.
Step 1: Build the monthly series
Extract 24-36 months of monthly balance sheet data for all NWC components. Spot reviews of year-end figures miss seasonality entirely.
Step 2: Calculate the key ratios
- DSO (Days Sales Outstanding): trade receivables / revenue × 30
- DPO (Days Payable Outstanding): trade payables / purchases × 30
- DIO (Days Inventory Outstanding): inventories / COGS × 30
Step 3: Identify anomalies
Are there months where DSO is unusually low? Where payables spike? These anomalies often reflect one-time collection efforts or payment timing games, particularly in the months before a sale process.
Step 4: Calculate the normalised NWC
Most practitioners use a 12-month rolling average to smooth seasonality. In highly seasonal businesses, a peer-year approach (averaging the closing month across multiple prior years) is more appropriate.
The seasonality trap
A business closing in December with a July peak activity will show a naturally low NWC at closing. If the peg is calculated only on closing-date data, the buyer under-estimates the peak funding requirement they will face in the following months.
Flagging this in an interview shows real operational understanding.
What interviewers want to hear
"I would build a 24-36 month monthly NWC series, calculate DSO/DPO/DIO, strip out anomalies, and use a 12-month rolling average to set the peg — adjusting for any known structural changes in the business."
The training programme includes Excel-based working capital models across multiple case studies, with seasonal data sets for you to normalise and test.