The Net Working Capital Adjustment Explained: How the Peg Moves the Final Price Pound-for-Pound, Where the Target Is Set, and Why the Estimate Is the Number Both Sides Fight Over

The Adjustment Enforces an Assumption Buried in the Enterprise Value

Most private acquisitions are struck on a cash-free, debt-free basis: the buyer agrees an enterprise value, strips out the target’s cash and repays its debt, and the residual is the equity price. What that headline quietly assumes is that the seller also leaves behind the working capital the business needs to keep running the day after completion — the receivables it is owed, the inventory on the shelf, the payables it owes. Hand over a business with its receivables collected and its suppliers unpaid, and the buyer inherits a company that will burn cash to rebuild its operating base. The net working capital adjustment exists to stop exactly that.

The mechanic is an intuition students already have: buying a business on a cash-free, debt-free basis is like buying a car with a full tank of fuel priced in. If the seller drains the tank before handover, the buyer should pay less; if the seller tops it up beyond normal, the buyer should pay more. The adjustment measures the “fuel” — the working capital — delivered at completion against an agreed normal level, and settles the difference in the price. Everything that follows is a consequence of that one idea.

What Counts as Working Capital — and What Deliberately Does Not

For this purpose, net working capital is the operating current assets minus the operating current liabilities: trade receivables, inventory and prepayments on one side; trade payables, accruals and other operating creditors on the other. It is a narrower figure than the textbook definition, because the two largest current items are carved out on purpose. Cash is excluded — it is swept to the seller and captured in the equity bridge. Debt and debt-like items are excluded — they run through the separate net debt bridge. Working capital is only the operating engine of the balance sheet, not its financing.

That carve-out is not housekeeping; it is where money is won and lost. An item that sits in both the working capital definition and the debt-like list — a large accrued bonus, deferred revenue, capex creditors, an unpaid dividend — can be counted against the seller twice: once as a reduction in working capital versus the peg, and again as a deduction in the net debt bridge. The definitions of “current liabilities” and “debt-like items” in the sale agreement have to be drawn so they do not overlap. Policing that boundary is a core part of the diligence the buyer runs before signing.

The Peg Is a Twelve-Month Average, and It Is the Most Negotiated Number in the SPA

The target — the “peg,” also called the working capital target or normalised working capital — is the agreed normal level the business should carry. Because working capital swings with seasonality and month-end timing, it is almost never a single spot figure. The standard approach is a trailing twelve-month average of monthly working capital, which smooths a retailer’s Christmas inventory build or a services firm’s quarter-end billing spike into one representative number.

Setting that average is the real negotiation, and it is adversarial by design. The seller argues for a lower peg: exclude an abnormal inventory build, treat a stretched-payables month as normal, strip out a one-off receivable. The buyer argues for a higher peg: normalise away the periods when the seller under-invested in stock, add back artificially delayed supplier payments, reflect the higher run-rate the growing business will actually need. Every pound the peg moves is a pound that flows straight to one side at completion — which is why the working capital schedule is often negotiated as hard as the price itself.

The Adjustment Is Pound-for-Pound, in Both Directions

Once the peg is fixed, the arithmetic is deliberately mechanical. Compare completion working capital to the peg; the difference adjusts the equity consideration one-for-one. Take a business bought for £200M on a cash-free, debt-free basis, with a peg set at £15M.

The symmetry matters. This is not a penalty on the seller; it is a settling-up. If the seller delivers £3M more working capital than normal, the buyer is receiving £3M of extra operating assets that will convert to cash, so paying £3M more is fair. The adjustment is neutral in theory — which is precisely why the leverage sits in the two places theory does not reach: the level of the peg, and the measurement of the completion number.

How Each Side Games the Completion Number

Because the delivered figure is measured on a single date, both sides have an incentive to dress it up in the weeks before completion. A seller who wants a higher completion number — and so a larger cheque — can stretch payables (delay paying suppliers, which lowers current liabilities and lifts net working capital), slow collections or pull invoicing forward (raising receivables), and build inventory ahead of the date. Each move inflates the balance-sheet snapshot without reflecting how the business normally runs, and each reverses in the buyer’s first weeks of ownership — the stretched suppliers get paid, the pulled-forward receivables are not replaced.

The buyer’s protection is not to police behaviour move-by-move but to have set the peg on a normalised twelve-month basis, so that a manufactured spike at completion stands out against the run-rate rather than being rewarded. Well-drafted agreements reinforce this with an ordinary-course covenant between signing and completion — the seller must run working capital consistently with past practice — and with consistency provisions requiring the completion accounts to be prepared on the same policies used to build the peg. The window-dressing game is real; the defence is a good peg and a tight definition, not a forensic audit of every invoice.

Estimate at Close, True-Up Sixty Days Later — Where the Disputes Live

The complication that makes working capital the most litigated line in a deal is timing. Nobody knows the exact completion balance sheet on the day of completion, so the price is settled twice. At closing the parties use an estimated completion statement and adjust the cash paid against the peg on that estimate. Then, typically 60 to 90 days later, formal completion accounts are prepared, and the difference between estimate and final is settled in cash — the “true-up.”

That second step is where deals go to war. The buyer, now in control and preparing the accounts, has every incentive to find working capital lower than estimated (money back); the seller scrutinises every provision and cut-off for signs the buyer is manufacturing a shortfall. Standard sale agreements route unresolved items to an independent accountant acting as expert, not arbitrator, whose determination is final and binding on the disputed lines. The mechanism is standard; the sums are not — a few million pounds of contested provisions on a mid-market deal is common, which is why the completion-accounts and dispute clauses of the signing-to-closing machinery get the attention they do.

Why Locked-Box Deals Avoid the Whole Thing

All of this — the peg, the estimate, the true-up, the expert — is the price of a completion-accounts deal, where the balance sheet is measured at closing. European sellers increasingly prefer the alternative: the locked box, which fixes the price on a historical balance-sheet date and dispenses with the completion adjustment entirely. There is no peg to negotiate and no true-up to fight over — the seller takes the economic risk and reward of the business from the locked-box date, and the buyer’s protection shifts from a working capital adjustment to a “leakage” covenant policing value that escapes to the seller in the interim.

The trade-off is certainty versus accuracy. A completion-accounts deal delivers a price that reflects the true working capital handed over, at the cost of a contentious post-closing process. A locked box delivers price certainty on day one, at the cost of the buyer accepting the balance sheet as it stood weeks or months before it owns the business. Knowing why a seller pushes for a locked box — no adjustment risk, faster close, control of the reference accounts — is as valuable in an interview as knowing how the adjustment itself works.

How This Shows Up in the Interview

“Why is there a working capital adjustment in an acquisition?” is a standard M&A and PE screen, and the weak answer describes the formula — completion working capital minus a target. The strong answer starts with the why: a cash-free, debt-free price assumes a normal level of working capital is delivered, and the adjustment enforces that assumption pound-for-pound. Then it names where the money actually moves — the peg, set as a twelve-month average and negotiated hard — and flags the two traps: the double-count with debt-like items, and the estimate-versus-true-up gap that sends disputes to an independent expert. Close by contrasting it with the locked box, and you have answered a question most candidates treat as plumbing at the level of someone who has sat through a completion.

Take Your Preparation Further

The adjustment is one leg of the bridge from enterprise value to the equity cheque, so read it alongside the pieces that make up the rest of that bridge: cash-free, debt-free explained for the basis the whole thing rests on, debt-like items and the net debt bridge for the parallel deduction it must not overlap, and the enterprise value to equity value bridge for how the legs assemble into a price. For the alternative that avoids the adjustment entirely, see locked box vs completion accounts.

Download the free M&A Process Cheat Sheet to keep the signing-to-closing mechanics in one place, and use the LBO Model Template to see how the working capital assumption feeds the equity value and the returns that follow from it.

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