Handling net working capital in the calculation of the purchase price
Ein A large portion of business valuations in today’s M&A landscape is conducted using the multiplier method. In this approach, sustainable revenue or sustainable operating income (EBIT or EBITDA) is multiplied by a factor derived from comparable transactions and fees paid across the industry.
Multiplying EBIT or EBITDA by the relevant multiplier yields the Enterprise Value (EV)—the value of the company excluding debt and cash.
From Enterprise Value to Equity Value: The Role of the Equity Bridge
In the Equity Bridge (reconciliation statement), various add-back items (e.g., cash, receivables from shareholders) and deduction items (e.g., bank liabilities, pension provisions) are taken into account to arrive at the Equity Value, which corresponds to the purchase price.
What Is Net Working Capital?
Net Working Capital (NWC) represents the working capital a business needs for its operational activities, calculated as current assets minus current liabilities. The part of the working capital that exceeds short-term financing must be funded by the company itself.
Two Approaches to Treating Net Working Capital
From my experience, two main schools of thought emerge regarding how to handle NWC in a transaction:
- Snapshot approach: Treat NWC as of the transaction date—if positive, add it in the bridge; if negative, subtract it.
- Average-based approach: Only consider deviations from an average NWC (e.g., over the past 12, 24, or 36 months).
Practical Example: Effects of Negative Net Working Capital
What explains the different approaches to handling net working capital—which can ultimately result in significant variations in the purchase price?
Let’s take the example of a company that achieves negative net working capital through effective management of its working capital: receivables are collected as quickly as possible, inventories are tightly optimized, and on the liabilities side, long payment terms are negotiated with suppliers and subcontractors.
Such a structure naturally results in higher liquidity, which, under the Equity Bridge logic, appears as an add-back item. However, from a technical standpoint, negative working capital actually reflects a liability—the company is essentially being financed by its suppliers.
Supporters of the first school of thought therefore subtract this “debt” in the Equity Bridge. Their rationale is based on multiple concerns:
they may doubt the sustainability of the working capital management, argue that market dynamics can shift (e.g., customers demanding longer payment terms or suppliers tightening theirs), and ultimately foresee a return to positive working capital, which would reduce liquidity and thus the company’s equity value.
By contrast, proponents of the second school of thought argue that the company has achieved structurally sustainable working capital management. In their view, the company consistently generates free liquidity by financing itself long-term via interest-free trade payables.
As a result, only deviations from the long-term average net working capital are considered in the Equity Bridge. For example, if the net working capital at the transaction date is lower than average—i.e., even more negative—this difference would be subtracted as an adjustment item.
Sustainability of Working Capital Management as a Key Factor
Ultimately, whether one approach or the other applies depends on the case. In project-driven businesses with volatile NWC, the snapshot approach may be more appropriate; for stable business contexts, the average-based approach may be the better fit. Always assess whether the liquidity generated by optimized working capital is truly “free” and withdrawable, in light of the company’s broader balance sheet.
Conclusion: There is no one-size-fits-all when it comes to valuing Net Working Capital.
Whether the snapshot or the average approach is more appropriate depends on the type of business and how reliable or sustainable the working capital structure is. A case-specific view is essential.
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