Liquidating net working capital
To protect the buyer’s interest in those future cash flows, many M&A transactions include a working-capital hurdle.Generally, working capital is defined as the operating liquidity available to a company.Whatever its size, the amount of working capital sheds very little light on the quality of a company's liquidity position.Another piece of conventional wisdom that needs correcting is the use of the current ratio and, its close relative, the acid test or quick ratio.An increase in net working capital is considered a negative cash flow and not available for equity.In other words, an increasing requirement for capital for short term operations in the company is not available to equity.Anything below 1 indicates negative W/C (working capital).While anything over 2 means that the company is not investing excess assets.
Before a deal closes, however, a seller can juggle the company’s assets and liabilities in ways that reduce the company’s future cash flows without affecting its EBITDA or, in turn, the purchase price.
To start this discussion, let's first correct some commonly held, but erroneous, views on a company's current position, which simply consists of the relationship between its current assets and its current liabilities.
Working capital is the difference between these two broad categories of financial figures and is expressed as an absolute dollar amount.
It’s usually calculated as current assets (excluding cash) less current liabilities (excluding debt), but the specific calculation of working capital for a transaction is defined in the stock-purchase or asset-purchase agreement.
Some deals might include cash and/or debt in the working capital or exclude certain current assets and/or liabilities, such as accrued interest expense or income taxes.
The formula for net working capital (NWC), sometimes referred to as simply working capital, is used to determine the availability of a company's liquid assets by subtracting its current liabilities.