What is a Working Capital Adjustment
A working capital adjustment is a mechanism used in mergers and acquisitions (M&A) to adjust the purchase price of a business based on changes in the company's net working capital from a predefined target.
Working capital represents the funds a business uses to meet its day-to-day operational expenses. It is calculated by subtracting current liabilities from current assets, and the resulting figure is considered the net working capital.
In an M&A transaction, the purchase price is typically based on the company's net working capital at the closing date. However, the actual working capital on the closing date may differ from the target amount agreed upon in the purchase agreement.
A working capital adjustment is used to address this discrepancy by adjusting the purchase price accordingly. If the actual net working capital is higher than the target, the purchase price may be increased, and if it is lower, the purchase price may be decreased.
The adjustment is calculated based on a formula specified in the purchase agreement, which typically takes into account the actual net working capital, the target working capital, and any other relevant factors. The adjustment ensures that the buyer pays a fair price for the company, taking into account the actual financial position of the business at the time of the acquisition.
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