Purchase Price Adjustments for Working Capital
Topic 92 explores the issues relative to the closing adjustment to the purchase price for working capital to be delivered at the closing by the seller. This topic also explores methods for establishing the appropriate level of working capital to be delivered by the seller at the closing. The purchase price agreement, particularly in asset deals but also in stock purchase deals, ordinarily sets forth an expected target dollar value of working capital (sometimes but not usually net operating capital) to be acquired as of the closing date.
TARGET AND ACTUAL WORKING CAPITAL DETERMINATION
- Buyers and sellers should carefully analyze the target's operating working capital employed (as defined in the letter of intent [LOI] or term sheet and generally excluding cash in such definition) over rolling annual periods to determine the historical ratio of the rolling average working capital to the annualized run rate of sales to assess how much working capital was employed to support the activity level of the business at any point in time.
- The historical ratio is then multiplied by the annualized run rate of sales expected as of the closing date to determine the target working capital level to be delivered by the seller at the closing.
- The significance of this target value is that any ongoing business requires a normal underlying level of working capital to support the activity level of operations at any point in time.
- The goal for a ...