Southfield, Mich.—March 7, 2018—Clayton & McKervey, an international certified public accounting and business advisory firm located in metro Detroit, advises businesses considering a sale to meticulously monitor their net working capital a year or two before they put themselves on the market. Net working capital (NWC) is defined as the current assets of a company, such as inventory, accounts receivable and prepaid expenses, in excess of current liabilities like trade payables and accrued wages—and is essentially what allows a business to operate from day-to-day, according to Margaret Amsden, CPA and Clayton & McKervey shareholder who heads the firm’s tax practice.
“When a company makes the choice to put itself up for sale, there are many factors it has to consider, but sufficiently managing net working capital at least 18 months before its sale is key to making sure that it doesn’t end up leaving significant value on the table,” Amsden said. “On the other hand, potential buyers will be making sure there’s enough net working capital to allow the company to operate in the days immediately following the transaction. It can be quite a balancing act as buyers generally set the target for the NWC.”
If business sellers want to maximize the proceeds of a sale, then the NWC will need to be maintained at a level as low as feasible to still operate the business. Amsden recommends that selling companies ask the following questions:
- Are we carrying excess inventory?
- Are we prepaying expenses that don’t need to be prepaid?
- Are we paying payables significantly ahead of their due date?
- Are we fully accruing expenses at the end of a period?
Amsden notes that within specific transactions, items normally included in the net working capital, such as cash, refundable tax payments, or related party receivables and/or payables may be excluded from the NWC definition as agreed to by the parties. Agreements generally require buyers to pay for excess NWC and require sellers to make up any NWC shortfall.
“This prevents sellers from altering the value of a company by driving down receivables or letting payables build up in the days leading up to a transaction,” Amsden said.
Purchasers will often look at the NWC over a 12- to 18-month timeframe and set a target for NWC based on the average of that period—underscoring the importance for a selling company to manage its NWC well before the transaction is expected to occur.
“Recognizing that it takes time to true up prepaid amounts and book accruals is vital to assuring that these adjustments are made accurately on a monthly basis as the business approaches its transaction,” Amsden said.
But, there are exceptions to the rule. It may become evident that there are valid reasons for a company to carry excess NWC such as:
- Excess inventory may be carried due to significant quantity discounts to be obtained or there may be certain inventory that is scarce.
- Accounts payable may be lower than customary to take advantage of early payment discounts.
“In these situations, it is important for the seller to articulate why there are exceptions so the buyer understands that the proper NWC targets have been set and the sale can proceed at the right price,” Amdsen concluded.
About Clayton & McKervey
Clayton & McKervey is a full-service CPA firm helping middle-market entrepreneurial companies compete in the global marketplace. The firm is headquartered in metro Detroit and services clients throughout the world. To learn more, visit claytonmckervey.com.