We know selling your business comes with a lot of questions. This is part of our ongoing series, breaking down everything you need to know step-by-step.

When you sell your company, most of your attention goes to the headline number (or the purchase price). But there's another term that quietly moves money at closing, and it catches first-time sellers off guard more than almost any other: the working capital adjustment.

Here's the good news. Once you understand the cycle behind it, it stops feeling like a trick and starts feeling like what it actually is: a fair way to hand the business over in normal running condition. Let's walk through it.

What working capital actually is

In its simplest form, working capital is what the business is owed minus what the business owes: your accounts receivable minus your accounts payable.

Think about how cash moves through your year. You buy materials and pay vendors. You do the work. You invoice your customers. And then, at some point, they pay you. On both sides there's a lag: your vendors might give you 30 or 45 days to pay them ("net 30" or "net 45"), and your own customers take their time paying you. Working capital lives in that gap.

The cycle, with a real example

A buyer we spoke with runs a business installing basketball courts, and it's a perfect illustration, because the work is seasonal.

In April, things are quiet. The team meets, plans the summer, and buys all the materials that will go onto gym floors. Those purchases pile up as expenses owed to vendors. Then June hits and the crew is working 60- and 70-hour weeks, wall to wall. The work gets done and the invoices go out—not back in April and May when the materials were bought, but in June and July.

The issue is that by mid-summer, accounts receivable is climbing fast (good—that's margin sitting on the balance sheet), but the customers haven't actually paid yet. Meanwhile the vendor bills from spring are coming due. Money is owed to you, but cash is going out to vendors. That's the negative part of the working capital cycle. Then the season winds down: you stop buying materials, the customer payments roll in, and cash builds back up.

Every business has a version of this. It isn't always seasonal, but that flow (cash out, then cash in, never quite in sync) is the working capital cycle. 

Why it becomes a deal term

When a buyer purchases your company, they're not just buying the equipment and the customer list. They're buying it in a particular state with a certain amount of money owed to you and a certain amount you owe out.

The problem is timing. If the deal happens to close at your high point, you'd be handing the buyer a balance sheet stuffed with receivables you earned—work you did, that they get to collect on. If it closes at your low point, the opposite. Where you land in the cycle on closing day shouldn't decide how much value changes hands. So both sides agree to normalize it.

It often feels like a tug of war. Every dollar of working capital that goes to the seller is a dollar the buyer doesn't get. Which is exactly why there's a standard, even-handed way to handle it.

How the adjustment works: the net working capital target

The most common approach in a straightforward business is to take a 12-month average of your working capital (again, receivables minus payables). Averaging across the whole year smooths out the seasonality, so it doesn't matter whether you close in busy June or quiet April. 

That average becomes the net working capital target: the normal level of working capital the business is expected to have when it changes hands.

Then you compare where you actually are on closing day to that target:

• Above the target: you're delivering a "fat" balance sheet, with more receivables than normal because of the work you did leading up to closing. That extra value comes back to you as the seller.

• Below the target: you're handing over fewer receivables than normal, so the purchase price comes down (or you owe the difference) to get the buyer back to a standard balance sheet.

In plain terms: deliver more than normal, you get paid for it. Deliver less, it's adjusted out. Neither side wins or loses based on the calendar.

The protection it builds in

The target also guards against bad behavior.

Picture a seller approaching closing who calls every customer and says, "Pay me right now and I'll give you 5% off." Receivables go to zero, the seller pockets the cash and walks. At the same time, he tells his vendors, "Don't worry, the new owner will pay you in 45 days." Now the buyer inherits a business with no incoming cash and a stack of bills to settle.

The net working capital target stops that cold. Because the buyer is comparing closing-day working capital to a normal average, draining the receivables and loading up the payables would just trigger an adjustment in the buyer's favor. The mechanism protects against the nefarious case and the perfectly innocent swings of a normal business—both get smoothed to the same fair baseline.

What this means for you as a seller

A few things worth internalizing before you're in it:

It's genuinely hard to predict, even for people who know it cold. Even 90 days into running a business it's stressful; you can run surprisingly close on cash, and $100K on the balance sheet isn't much when it's a single month of expenses.

It is meant to be fair. The adjustment cuts both ways. If you hand over a strong balance sheet, you get that value back; you're not giving anything away by delivering the business in good shape.

And it's negotiable, within reason. How the target is set, which accounts count, and the closing mechanics are all on the table. This is one of those terms where having an advisor who's done it before genuinely pays off; they'll make sure the target reflects your real business and that you're not leaving money on the table.

Final Thoughts

Working capital ensures business changes hands in normal running condition (no better, no worse) regardless of where you happen to be in your cash cycle on closing day.

But understanding the concept is different from navigating it in your actual deal, where the numbers are real and the stakes are high. A Baton advisor has sat across the table on transactions like yours and knows how to make sure the target is set fairly, the right accounts are included, and you walk away with what you earned. You don't have to figure it out alone.