Working Capital in M&A: Definition and Benchmarks
What working capital means in an M&A context, how it is defined in practice, and what benchmarks FDD analysts use to assess it.
Working capital is a concept most finance professionals encounter early in their training — but in an M&A context, the definition is more specific and the stakes are much higher than in a standard financial analysis course. This post explains the M&A definition, how it differs from the accounting textbook version, and what benchmarks FDD analysts use.
The Accounting Definition vs. the M&A Definition
In accounting, working capital is simply:
Accounting Working Capital = Current Assets − Current Liabilities
This includes cash, financial debt (current portion), tax payables, and deferred revenue. In M&A, this definition is not useful because cash and financial debt are dealt with separately in the net debt bridge, and tax items are often excluded.
The M&A / FDD definition of NWC typically includes only operational items:
NWC (M&A) = Trade Receivables + Inventories + Other Operating Current Assets − Trade Payables − Other Operating Current Liabilities − Accrued Liabilities
Explicitly excluded:
- Cash and cash equivalents (dealt with in net debt)
- Financial debt (dealt with in net debt)
- Current income tax payable/receivable (sometimes excluded)
- Deferred revenue in some deal structures
The exact definition is agreed in the SPA and is critical for the NWC mechanism.
Why the Definition Matters
In a completion accounts deal, the price adjustment is:
Adjustment = Actual NWC − NWC Target
If the NWC definition includes an item that generates a €1m swing, that is €1m directly affecting deal proceeds. Buyers and sellers spend considerable time negotiating which items are "in" or "out" of the definition.
Common Items Disputed in NWC Definitions
- Deferred revenue: Some buyers include it (they must deliver the service), some sellers exclude it (it is a timing item)
- VAT payable / receivable: Sometimes included as operational, sometimes excluded
- Employee-related accruals: Usually included, but the definition of "normal" accruals can be debated
- Customer deposits: Sometimes a liability in NWC, sometimes treated as debt-like
NWC Benchmarks
FDD analysts use several benchmarks to assess NWC normalcy:
Historical NWC Ratios
- NWC as % of revenue (typically 5–15% for most businesses, higher for inventory-heavy companies)
- DSO (sector-specific norms: 30–45 days for many B2B services; 60–90 days for construction or project businesses)
- DPO (20–60 days is typical; above 90 days may indicate stretched payables)
- Inventory days (highly sector-specific: 30 days for fast-moving goods, 180+ days for manufactured goods or seasonal businesses)
Peer Comparison
Where available, comparable public company filings provide useful benchmarks for NWC ratios. Significant deviations from peers should be explained.
Management's Own Commentary
Management accounts often include commentary on working capital. Any management narrative that explains NWC movements should be tested against the data.
Conclusion
Working capital in M&A is a specific, defined concept that differs meaningfully from the accounting textbook definition. Getting it right — including which items are in and out of the definition — is fundamental to FDD analysis and SPA negotiations.
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