I regularly chat with clients who intend to sell a manufacturing business in the relative near term. When advising these prospective sellers on maximizing the value of the sale, I suggest a detailed plan, including meticulously monitoring net working capital a year or two before the company is put on the market.

Net working capital (NWC) is defined as the current assets of a company, such as inventory, accounts receivable and prepaid expenses, in excess of current liabilities like trade payables and accrued wages — and is what allows a business to operate from day-to-day. When a company decides to sell, there are many factors to consider, but sufficiently managing net working capital before the sale is key to making sure significant value isn’t left on the table. Concurrently, potential buyers will be making sure there’s enough net working capital to allow the company to operate in the days immediately following the transaction. It can be quite a balancing act, because buyers generally set the target for the NWC.

To maximize the proceeds of a sale, the NWC will need to be maintained at a level as low as feasible to still operate the business. Companies should ask these four questions:

1. Are we carrying excess inventory?
2. Are we prepaying expenses that don’t need prepayment?
3. Are we paying payables significantly ahead of their due date?
4. Are we fully accruing expenses at the end of a period?

Within specific transactions, items normally included in the net working capital, such as cash, refundable tax payments, or related party receivables and/or payables may be excluded from the NWC definition as agreed to by the parties. Agreements generally require buyers to pay for excess NWC and require sellers to make up any NWC shortfall. This prevents sellers from altering the value of a company by driving down receivables or letting payables build up in the days leading up to a transaction.

Buyers often look at the NWC over a 12- to 18-month timeframe and set a target for NWC based on the average of that period—underscoring the importance for a selling company to manage its NWC well before the transaction is expected to occur. Recognizing that it takes time to true up prepaid amounts and book accruals is vital to assuring that these adjustments are made accurately on a monthly basis as the business approaches its transaction; but there are exceptions to the rule. It may become evident there are valid reasons for a company to carry excess NWC, such as:

1. Excess inventory may be carried due to significant quantity discounts to be obtained or there may be certain inventory that is scarce
2. Accounts payable may be lower than customary to take advantage of early payment discounts

In these situations, it is important for the seller to articulate why there are exceptions so the buyer understands the proper NWC targets have been set and the sale can proceed at the right price.

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Clayton & McKervey is an MMA Premium Associate Member and became a member company in 2018. Visit online: www.claytonmckervey.com.

About the Author

Margaret Amsden, CPA, MST leads the tax department at Clayton & McKervey. She may be reached atmamsden@claytonmckervey.com.