How to Determine the Proper Net Working Capital (And Why “It’s My AR” Isn’t the Right Way to Think About It)

Of all the terms that surface in a business sale, none causes more confusion — and more late-stage friction — than net working capital. Buyers treat it as a given, non-negotiable mechanic. Sellers, especially first-time sellers, often hear about it for the first time during due diligence and react the same way: “That’s my receivables. My customers owe that money to me, not to the buyer.” That single misunderstanding derails more deals in the final 30 days than almost anything else in the purchase agreement.

This piece is written for business owners preparing to sell, and for the brokers and advisors who have to walk them through why the working capital conversation isn’t a buyer trying to claw back value — it’s how every properly structured sale works.

What Net Working Capital Actually Is

Net working capital (NWC) is the capital a business needs on hand, cycling through its normal operations, to keep running without an outside cash infusion. In its simplest form:

Net Working Capital = Current Assets − Current Liabilities

In an M&A context, the definition gets narrower and more specific. It’s not every current asset and liability on the balance sheet — it’s the operating ones, the items that exist purely because the business is doing business:

Accounts receivable (money owed by customers for delivered goods/services)
Inventory, where applicable
Prepaid expenses and deposits
Accounts payable (money owed to vendors)
Accrued payroll, accrued benefits, accrued sales tax, and other routine accrued liabilities

Cash, debt, and the current portion of loans are deliberately excluded — those are handled separately through the cash-free, debt-free provisions of the deal. NWC is meant to isolate one specific question: how much money does this business need tied up in receivables, prepaid items, and short-term obligations just to open its doors and operate normally tomorrow?

Why It’s Vital in a Sale

Think about what actually happens the day after closing. The buyer now owns the company. Customers still owe money on open invoices. Vendors still expect to be paid on their normal terms. Payroll still runs on schedule. None of that stops just because ownership changed hands.

If the seller were allowed to collect every outstanding invoice and drain the bank account right up to closing, while leaving all the unpaid bills for the buyer to cover, the buyer would be handed a business that technically has all its assets and operations intact — but no fuel to run on. The buyer would have to inject new cash on day one just to keep the lights on, money that has nothing to do with growing the business and everything to do with covering a gap the seller created by walking away with the working capital.

The NWC mechanism exists to prevent exactly that. It ensures the buyer receives a business with enough operating capital to function normally from day one, and it protects the seller from being unfairly penalized for keeping the business appropriately funded right up to the sale. It works in both directions — that’s the part that gets lost when a seller hears “you don’t get to keep all your receivables” and assumes it’s a one-sided taking.

A useful analogy for sellers: when you sell a car, the buyer expects a reasonable amount of gas in the tank, or at least doesn’t expect to find it bone dry and stranded on the drive home. Nobody thinks that’s the seller being generous — it’s just the deal. The same principle applies to a business, just with receivables and payables instead of a fuel gauge.

Addressing the “It’s My AR” Objection Directly

This deserves its own section because it’s the single most common point of resistance a broker will face, and it’s worth understanding the seller’s logic even while correcting it.

The seller’s reasoning usually goes: “I did the work. My customers owe me for it. That receivable exists because of effort I already put in, before the sale. Why should the buyer get credit for something I earned?”

The answer isn’t that the seller is wrong about who earned it — it’s that the purchase price was never meant to be separate from the working capital in the first place. The enterprise value the buyer agreed to already assumes the business comes with a normal, healthy level of working capital attached. If the seller pulls the receivables out before closing, that’s not “keeping what’s theirs” in isolation — it’s changing what’s being delivered without changing the price. The buyer priced the business assuming it would arrive with roughly the working capital it normally carries. Strip that out, and the buyer is paying full enterprise value for a business missing a piece it was priced to include.

Put another way: the seller isn’t being asked to give the receivables away for free. The value of a normal, healthy level of working capital is already baked into the purchase price. The NWC peg is the mechanism that confirms the seller actually delivers what the price assumed — no more, no less. If the business happens to carry more working capital than normal at closing, the seller gets paid extra for it. If it carries less, the price comes down. It’s symmetrical, not punitive.

This is usually the moment a broker needs to reframe the conversation from “what are they taking from me” to “what did I already get paid for.”

How to Actually Calculate the Right NWC Target

Step 1: Pull 12 to 24 Months of Historical Balance Sheets

You need enough history — ideally monthly — to see the business’s normal operating range, not a single snapshot that might be unusually high or low.

Step 2: Identify the True Operating Components

List out, month by month:

Accounts receivable
Inventory (if applicable)
Prepaid expenses and deposits
Accounts payable
Accrued liabilities (payroll, benefits, sales tax, commissions, etc.)

Step 3: Strip Out Non-Operating Items

Remove cash and cash equivalents, any debt or current loan balances, income taxes payable/receivable, and related-party or intercompany balances. These are either handled elsewhere in the deal structure or don’t reflect the arm’s-length operating business.

Step 4: Average Across a Trailing Period to Normalize for Seasonality

Take the monthly NWC figure (current operating assets minus current operating liabilities, as defined above) for each of the trailing 12 months and average them. This matters enormously for seasonal businesses — a landscaping company, a tax prep firm, a retailer with a holiday season — where a single month-end number could be misleadingly high or low. The 12-month average smooths that out and reflects what the business actually needs on a normal operating day.

Step 5: Remove One-Time Distortions

If a specific month included an unusual bad debt write-off, an out-of-pattern prepayment, or a one-time accrual, both sides typically agree to normalize that month before it’s included in the average. This is usually done collaboratively between the buyer’s and seller’s accountants.

Step 6: Decide the Gray Areas Explicitly

A few items don’t have one standard treatment and need to be negotiated and written down clearly:

Deferred revenue — cash already collected for work not yet performed. Buyers often want this treated as a direct reduction to price, separate from the general NWC calculation, since it represents a future obligation with no future cash attached.
Aged receivables — many buyers exclude receivables older than 60 or 90 days from the NWC calculation, or subject them to a holdback, on the reasoning that a 120-day-old invoice is a collections problem, not working capital.
Deposits held for customers — needs to be evaluated based on whether it represents a real forward obligation.

Step 7: Set the Peg as a Specific Number in the Purchase Agreement

The trailing 12-month average becomes the target NWC — the amount the seller is contractually expected to deliver at closing. The purchase agreement should spell out, line item by line item, exactly what’s included and excluded, because ambiguity here is where disputes come from later.

Step 8: Estimate at Closing, Then True Up

Since a perfectly finalized closing-date balance sheet usually isn’t available the moment the deal closes, the parties use an estimated closing balance sheet to calculate the initial payment. Within 30 to 90 days after closing, a final closing balance sheet is prepared, actual NWC is calculated, and the purchase price is adjusted — up if the seller delivered more than the peg, down if less. Most agreements specify an independent accountant as a tiebreaker if the two sides can’t agree on the final figure.

A Simple Illustrative Example

Say a services business has averaged, over the trailing 12 months:

Accounts receivable: $150,000
Prepaid expenses: $20,000
Accounts payable: ($60,000)
Accrued payroll and benefits: ($35,000)

Average NWC = $150,000 + $20,000 − $60,000 − $35,000 = $75,000

That $75,000 becomes the peg. Note peg” is shorthand for the net working capital target — a specific dollar figure written into the purchase agreement that the seller is contractually expected to deliver at closing. If, at closing, the actual calculated NWC comes in at $90,000, the seller is owed an additional $15,000 on top of the agreed purchase price. If it comes in at $60,000 — because the seller collected receivables aggressively and delayed paying vendors right before closing — the purchase price drops by $15,000. Same formula, same fairness, in either direction.

Talking Points for Brokers Explaining This to a Resistant Seller

A few framings tend to land better than reciting the mechanics:

“The receivables aren’t being taken from you — their value is already built into the price you’re being paid. This just confirms you deliver what the price assumed.”

“If you strip out the working capital right before closing, you’re not keeping something extra — you’re changing what the buyer receives without changing what they pay. That’s the part that becomes a legal problem, not a fairness problem.”

“This protects you too. If the business is carrying more working capital than normal at closing, you get paid more for it. It’s not a one-way street.”

“Every serious buyer will ask for this. A buyer who doesn’t ask for a working capital adjustment either doesn’t understand deal structure or is planning to renegotiate price after finding the gap in diligence — neither is a good sign.”

The Bottom Line

Net working capital isn’t a buyer’s negotiating trick — it’s the mechanism that makes the purchase price mean what both sides think it means. Getting the definition, the exclusions, and the trailing-average methodology nailed down early — ideally at the letter of intent stage, not buried in a purchase agreement schedule three weeks before closing — is what keeps a seller’s “that’s my money” reaction from turning into a deal-threatening dispute in the final stretch.