# How to Calculate Working Capital in a Manufacturing M&A

One of the most challenging aspects of a manufacturing M&A involves calculating the working capital (WC) of the company that’s being acquired. WC isn’t static: It fluctuates from day to day. That’s why it’s critical for both seller and buyer to agree on the sum so they’re on the same page when it’s time to seal the deal.

## How to Calculate Manufacturing Working Capital

For the purposes of an M&A, a company’s working capital consists of its current assets (not including cash) minus its current liabilities (not including funded debts—such as mortgages—and income taxes).

To calculate the value of the assets, you need to include accounts receivable and inventory. Inventory can consist of raw materials, products in production, and finished goods. In some cases, marketable securities are included.

During the M&A process, it’s essential to ensure a fair price is assigned to the inventory—one that’s based on current market value. However, if any inventory is stored for a long time, then you need to take possible devaluation or appreciation into account.

To calculate the total sum of a company’s liabilities, add accounts payable to the total value of any orders that have been paid for but not yet fulfilled.

## Why Manufacturers Have More WC

Manufacturing companies typically have relatively more WC than businesses in other industries. The reason for this is that manufacturers usually have more inventory. Moreover, the longer it takes for the inventory to move through the production cycle and out the door, the more WC is tied up in the company.

Note that as more manufacturers implement digitization and adopt smart manufacturing technologies, the less inventory they’ll have. As a result, WC ratios are likely to decline somewhat.

## How Working Capital Is Included When Closing the Deal

In general, during an M&A, the buyer and seller will establish a base WC by averaging the daily working capital over an extended period of time, usually between three and six months. This base WC represents the dollar amount that’s initially included in the M&A transaction price.

The final step in the process is for the buyer and seller to calculate any adjustment to the WC. This occurs between 30 and 60 days after the transaction and involves determining what the actual WC was on the closing date. If that sum was more than the base WC included in the transaction price, then the buyer has to pay the difference to the seller in order to cover the additional value. If it was less, then the buyer essentially paid too much for the company, and the seller has to refund him or her the difference.

## Join the Conversation

If you have experience calculating the WC for a manufacturing M&A or if you have any questions about the process, we want to hear from you. Join the conversation by leaving your comments below.

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Frances Brunelle is the founder of Accelerated Manufacturing Brokers, Inc., which specializes in the sale of lower middle-market manufacturing companies nationally. Fran and her team help to ensure the continuity of U.S. Manufacturing by transitioning ownership to the next generation of entrepreneurs. Recently Fran was named to 2020 Most Influential Women in Mid-Market M&A (Mergers & Acquisitions). Fran is also the host of the WAM (Women and Manufacturing) podcast, a Jacket Media production. Fran writes on topics that help manufacturing business owners prepare their companies for sale and navigate the sale process to ensure a positive financial result in support of their retirement.

1. Ed Pratesi on 2017-05-26 at 3:26 pm

An excellent introduction to the understanding of how working capital is considered in the M&A process. A great tool for sellers and buyers.

• Frances Brunelle on 2017-06-07 at 9:31 pm

Ed,

Thanks for taking the time to read and comment. Much appreciated! What other topics would you like us to write about?

Best regards,

Fran

2. Joe Trobert on 2017-07-06 at 12:40 pm

Let’s say that the EBIT multiplier is a given number, say 6 for what I do. And let’s say earnings is \$500 for the year. Let’s say that active inventory and finished goods inventory is normally \$300K.

If I multiply \$500K x 6 = \$3 mil, do I add the \$300 K to make the base selling price \$3.3 mil?

I know I am over simplifying this but, I want to know current M&A protocall on how to treat the inventory piece of working capital.

Please do not call my office or send information to my office — email only, Thanks.

• Frances Brunelle on 2017-08-01 at 1:29 pm

Hi Joe,

Per your request – we emailed a respone

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