Working Capital

Working capital is the difference between current assets and current liabilities. It shows how well a company can cover its ongoing payment obligations from its own resources. In M&A, a narrower net working capital concept is often used that excludes cash and financial debt. The reason for that boundary is the logic of the equity bridge: cash and financial liabilities are captured separately there, so they must not appear again in working capital, since otherwise the same item feeds twice into the price.

What remains is essentially inventory, trade receivables, prepayments made and other short-term assets less trade payables, prepayments received and other short-term obligations. Which provisions and accruals are included is a matter of negotiation. Economically the measure matters twice over: an increase ties up capital and reduces free cash flow, while a reduction can release liquidity and create value after completion. In classic business analysis the broad definition is also used as a liquidity measure, where a negative value means that current liabilities exceed current assets.

Working capital is managed through three levers: inventory coverage, customer payment terms and supplier payment terms. Together they form the cash conversion cycle, calculated as days inventory plus days receivable less days payable, which states how many days elapse between paying for materials and receiving payment from the customer. At 60 million euros of annual revenue, reducing days receivable by one day releases roughly 165,000 euros of liquidity, which is why optimising this cycle is among the fastest sources of value after an acquisition. Seasonal businesses show very different levels over the year, which is why purchase agreements agree an average across several month-end dates as the reference.