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.
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