A working capital adjustment is a mechanism in a business sale that increases or decreases the final purchase price based on the net working capital in the business at settlement compared to an agreed target. Working capital — current assets minus current liabilities — is the money that keeps a business running day to day. In Australian SME transactions between $1 million and $20 million, getting this figure wrong, or not understanding it at all, can cost a seller $100,000 to $300,000 without anyone doing anything dishonest.
It’s one of those terms that sounds technical and therefore gets skimmed in the heads of agreement. It shouldn’t be.
What Is Working Capital in a Business Sale?
Working capital is the net short-term financial position of a business. The formula is:
Working capital = Current assets − Current liabilities
Current assets typically include:
- Trade debtors (invoices you’re owed but haven’t collected)
- Inventory and stock on hand
- Prepaid expenses
Current liabilities typically include:
- Trade creditors (invoices you owe to suppliers)
- Accrued wages and superannuation
- GST payable (net of GST credits)
- PAYG withholding
Cash is almost always excluded from working capital in a business sale. The standard approach is that the seller keeps the cash, and the working capital calculation is done on a cash-free, debt-free basis. That cash-free treatment is important to understand because it means you’re not handing over your bank balance — you’re handing over the operational fuel the business needs to keep running.
A business with $2 million in revenue might carry $350,000 in working capital at any given time. That’s real money sitting in debtors and stock that the buyer is relying on to keep trading from day one.
The Working Capital Peg
Before exchange of contracts, the buyer and seller negotiate a “working capital target” — also called the peg or benchmark. This is the specific dollar amount of working capital the seller agrees to leave in the business at settlement.
The peg is typically calculated as the average of the last 6 to 12 months of month-end working capital figures. For a business with consistent trading, this is reasonably straightforward. For a seasonal business, it needs more thought (more on that below).
Here’s the core rule every seller needs to understand: a seller who lets the buyer’s team define the peg without pushback is usually leaving money on the table. The buyer’s advisors will set the peg high because it protects the buyer — a high peg means more working capital handed over at settlement. Your job is to land it somewhere fair, which in practice means getting your own advisors to run the numbers before you sign anything.
How the Adjustment Works at Settlement
The mechanics work like this:
- Actual working capital above the peg → buyer pays you the difference
- Actual working capital below the peg → purchase price is reduced by the shortfall
If the agreed peg is $600,000 and the actual working capital at settlement is $450,000, the purchase price drops by $150,000. If it’s $750,000, the buyer pays you an extra $150,000. That swing can happen in either direction through completely normal business operations in the weeks before settlement.
Most deals use a two-step process. An estimated working capital figure is used on settlement day, based on management accounts. Then, 30 to 90 days post-settlement, a final determination is made using audited or reviewed accounts. The difference between the estimate and the final figure is settled between the parties — buyer to seller, or seller to buyer, depending on which way it falls.
That gap between the estimate and the true-up is where disputes live. I was involved in a deal last year where the seller’s accountants and the buyer’s accountants came in $290,000 apart on the same set of books — the main sticking point was how to treat a large GST refund that was in transit at settlement date. Both teams had defensible positions. They resolved it through the dispute mechanism in the sale agreement (which, to the seller’s credit, had actually been properly negotiated). It still cost six weeks and tens of thousands in professional fees.
The lesson isn’t that disputes are inevitable — it’s that a well-drafted working capital definition in your sale agreement reduces the scope for them considerably.
What’s Included — and What’s Not
The definition of working capital in the sale agreement is where it gets precise, and where sellers who haven’t read their docs closely enough get caught.
Typically included:
- Trade debtors (aged under 90-120 days — older debts are often excluded or discounted)
- Stock valued at cost (not selling price)
- Prepaid expenses
- Trade creditors
- Accrued liabilities — wages, super, annual leave provisions
Typically excluded:
- Cash and cash equivalents
- Bank borrowings and overdrafts
- Income tax payable (sometimes negotiated either way)
- Intercompany loans
- Capital expenditure items
The ATO-related items — GST payable, PAYG withholding, superannuation — are where Australian sellers sometimes get surprised. These are real liabilities on your balance sheet, and depending on your settlement timing relative to your BAS lodgement date, they can fluctuate by $50,000 to $200,000 in a matter of weeks. Whether they’re in or out of the working capital calculation depends entirely on what the sale agreement says.
This is also why the due diligence checklist matters so much — buyers will scrutinise your current assets and liabilities closely, and any discrepancy in how those are characterised can flow directly into the working capital calculation.
How to Negotiate the Working Capital Peg
As a seller, you want the peg set as low as practically defensible — because if working capital at settlement is above the peg, you get paid extra; if it’s below, you get docked.
Practical levers available to you:
1. Use a longer lookback period. Twelve months captures more variation and smooths out short-term anomalies that might inflate the peg. A buyer pushing for six months may be trying to capture a high-working-capital period.
2. Negotiate a working capital band, not a fixed number. A collar of ±3–5% of the peg means small variances at settlement don’t trigger a price adjustment. This is common in well-negotiated deals and saves both parties from fighting over immaterial differences.
3. Push on ATO liabilities. GST payable, PAYG withholding and superannuation can swing significantly based on timing. If they’re in scope and you settle the day before a BAS lodgement, you’re carrying those obligations in the calculation. Negotiate them out, or agree on a normalised treatment.
4. Control the settlement date. Mid-month settlement, in your average trading period, is usually cleaner than month-end or your peak season.
Working capital is also a distinct negotiation from earn-out agreements — both are price adjustment mechanisms, but earn-outs are forward-looking (tied to future performance) while working capital adjustments are backward-looking (tied to the state of the business on settlement day). Sellers sometimes conflate them when they’re reading the heads of agreement. They work very differently.
Seasonal Businesses: A Specific Problem
For any business with a pronounced seasonal trade cycle — a Queensland hospitality operator, a WA mining services business with cyclical project timing, a retail business with a Christmas peak — working capital can swing dramatically across the year.
A business that normally carries $500,000 in working capital might sit at $950,000 in November and $200,000 in March. If your peg is set as a simple annual average and you settle in November, you’re potentially handing over $450,000 more than the “normal” working capital position — with no adjustment mechanism to compensate.
The solution is a seasonally-adjusted peg: instead of averaging all 12 months, you use the working capital figure from the same calendar period in prior years. It’s more complex to calculate and more contentious to negotiate, but it reflects what the business actually looks like at the point of settlement — which is what both parties should want.
Four Mistakes Australian Sellers Commonly Make
Not understanding the peg before heads of agreement. Once you’ve signed the LOI or heads of agreement, it’s much harder to relitigate the methodology. The time to push back on peg definition is before you sign, not during due diligence.
Running down debtors to harvest cash before settlement. Some sellers collect receivables aggressively in the weeks before settlement to maximise the cash they keep. But if those collections drop working capital below the peg, you lose in the price adjustment more than you gained in cash — and you’ve possibly flagged unusual behaviour that spooks the buyer.
Forgetting annual leave provisions. Employee entitlements — annual leave, long service leave — are current liabilities and are usually included in working capital. In a business with long-tenure staff, these can be substantial. A manufacturing business with 30 staff averaging 10 years’ service can carry $250,000 or more in accrued leave (which is more than most sellers expect, and it’s sitting right there on the balance sheet).
Skipping the pre-settlement estimate. Before you settle, have your accountant prepare a working capital estimate using the agreed methodology. If you’re going to miss the peg, you’d rather know in advance — and you may still have time to remedy it or renegotiate the settlement.
The M&A process has a lot of moving parts in the final stretch before completion. Working capital is one of the most financially material ones, and it gets less airtime in vendor preparation conversations than it deserves.
How This Fits With Your Sale Structure
Whether your deal is structured as an asset sale or share sale affects the working capital treatment. In a share sale, the buyer acquires the entire entity — including its balance sheet — so the working capital peg is central to the deal mechanics. In an asset sale, specific assets change hands, and the working capital question is partly about what receivables, stock and payables transfer with those assets and what stays with the seller’s entity. The mechanics differ, but the negotiation principles are similar.
For more detail on how the sale structure affects your net proceeds — including tax on selling a business — those are separate questions worth thinking through before you commit to a deal structure.
If you’re preparing to sell your business and you want to understand how working capital could affect your final number, a valuation conversation is a good place to start. Use the valuation calculator to get a baseline, or contact us to talk through the specifics of your situation.