Normalised Working Capital

03 September, 2026 · Author: Vaibhav Sundecha · 8 min read

Normalised Working Capital: The Number That Can Change What You Receive for Your Business

You have found a buyer for your company.

The buyer has made an attractive offer, perhaps based on a multiple of your company’s normalised EBITDA. You begin thinking that the most difficult part of the transaction is over.

Then you see a term in the buyer’s Letter of Intent:

It sounds like an accounting formality. It is not.

The working capital calculation can directly affect the final amount you receive for your business. If the working capital delivered on the closing date is lower than the agreed target, the buyer may reduce the purchase consideration. If it is higher, the seller may be entitled to an increase, depending on the agreed transaction terms.

This is why business owners should understand normalised working capital before signing the Letter of Intent, and certainly before agreeing to the definitive transaction documents.

First, what is working capital?

Think about the money required to keep your business operating every day.

Your company may have:

·       Money to be collected from customers

·       Raw materials and finished goods in stock

·       Advance payments made to suppliers

·       Bills that need to be paid to vendors

·       Employee costs and other expenses that have become payable

·       Taxes and statutory dues waiting to be deposited

In simple terms:

Current operating assets usually include trade receivables, inventory, operating advances and prepaid expenses. Current operating liabilities generally include trade payables, accrued expenses and other operating liabilities.

In many M&A transactions, cash and borrowings are excluded because they are dealt with separately while calculating the final equity value. The exact list of included and excluded items must therefore be clearly agreed between the buyer and seller.

What does “normalised” working capital mean?

The working capital shown in your balance sheet is only a snapshot on a particular date.

That snapshot may include unusual, old or non-recurring items that do not represent the amount your business normally requires.

Normalised working capital is an estimate of the genuine operating working capital needed to run the business in its ordinary course.

A simple way to think about it is:

Before deciding the normal level, each major balance sheet item should be examined.

1. Trade receivables

Suppose your company normally gives customers 60 days to pay, but certain invoices have remained unpaid for several months.

The buyer may question whether those old receivables are fully recoverable. Such overdue or stretched receivables may be excluded, reduced or separately provided for while calculating normalised working capital.

2. Inventory

The inventory figure in the accounts may not always reflect inventory that can be sold in the normal course of business.

Adjustments may be required for:

·       Slow-moving or non-moving stock

·       Discontinued products

·       Damaged or obsolete goods

·       Differences between physical stock and accounting records

·       Inventory recorded above its cost or net realisable value

·       Goods that are not ordinarily sold by the company

The reported inventory may also need to be increased where valid stock has not been fully recorded or valued. Examples include goods in transit, unrecorded scrap or consumables, work in progress valued incorrectly, or freight and production overheads that have not been properly included in inventory cost.

3. Deposits and advances

Not every deposit or advance is part of normal business operations.

For example, an advance paid for buying machinery or property is connected with capital expenditure, not routine working capital. Staff advances awaiting adjustment and inter-corporate deposits outside the ordinary course of business may also need to be excluded.

4. Trade payables and unpaid expenses

Old supplier balances require careful treatment.

If a supplier normally offers 60 days of credit, but the company has not paid that supplier for more than 180 days, the overdue amount may not represent ordinary working capital. It may instead be treated separately, including potentially as a debt-like item under the transaction terms.

Overdue statutory dues, such as GST, TDS, provident fund, ESIC and taxes, may also be treated as debt-like items rather than normal operating liabilities. Their final treatment must be agreed in the transaction documents.

Why does the buyer ask for normal working capital?

Imagine buying a running car but discovering that its fuel tank is almost empty. The car is operational, but you must immediately spend money before you can use it normally.

The same principle applies when a buyer acquires a business.

The buyer generally expects the company to be handed over with enough receivables, inventory and other operating assets, after deducting normal operating liabilities, to continue operating without an immediate cash injection.

For this reason, the buyer and seller agree on a target level of working capital, sometimes called the working capital peg.

At closing:

·       If actual working capital is below the target, the purchase price may reduce.

·       If actual working capital is above the target, the purchase price may increase.

·       If actual working capital matches the target, no working capital adjustment is required.

The basic commercial calculation is:

External M&A guidance similarly describes the target as the normal level expected to be delivered at closing and notes that closing accounts adjustments can affect purchase price on a dollar-for-dollar basis, subject to the agreed terms.

The problem with using one fixed amount

Working capital does not remain constant throughout the year.

This is especially important for seasonal businesses.

Consider an agrochemical company. It may purchase and hold inventory before the monsoon, sell much more during the agricultural season, and collect customer receivables later. Its inventory, receivables and supplier balances may therefore change substantially from one quarter to another.

A fixed rupee target based only on the year-end balance may produce an unfair result if the transaction closes during a different part of the operating cycle. Your article accordingly recommends considering working capital in relation to sales and reviewing monthly or quarterly balances instead of relying only on a single year-end figure.

Let us look at a practical example.

Practical illustration: A seasonal business

The following example covers nine quarters. All monetary values are in ₹ million.

Chart 1: Quarterly sales show strong seasonality

The pattern is clear. Sales rise sharply in the fourth quarter of each year and are considerably lower in other quarters. A working capital target based only on a fourth-quarter or year-end position may therefore not represent the company’s requirement on another closing date.

Chart 2: The problem with using year-end data only

In this case, the seller may suffer a deduction even though the lower working capital is mainly because of the seasonal timing of closing and not because the business was under-funded.

Chart 3: Working capital days give a more comparable picture

Working capital days express working capital in relation to the level of sales.

For this illustration:

The company’s absolute working capital moves from approximately ₹25 million to ₹112 million across the illustration. This demonstrates why a single fixed amount can be misleading for a business with seasonal sales.

Although the amount of working capital changes considerably, working capital days remain within a more understandable range. Based on the data in this example, the average is approximately 85 days.

If a transaction closes at the end of Q1 FY27, the company has approximately 85 working capital days. This is close to the nine-quarter average. On this basis, the company would have delivered a broadly normal level of working capital, assuming the same definitions and agreed adjustments apply.

Why this approach can be fairer

For this company, year-end falls in Q4, which is also its peak sales period. Comparing selected year-end balances with a closing date in another quarter can mix two different points in the seasonal cycle.

A more representative analysis may compare:

·       Working capital and sales from corresponding periods

·       Monthly or quarterly working capital trends

·       Working capital days across the operating cycle

·       Like-for-like seasonal periods

·       Exceptional items that should not influence the target

Five questions every seller should ask before agreeing to the target

1. What exactly is included in working capital?

Do not leave the definition to be decided after signing the Letter of Intent.

Agree how the transaction will treat:

·       Old receivables

·       Slow-moving inventory

·       Customer and supplier advances

·       Statutory liabilities

·       Related-party balances

·       Capital expenditure advances

·       Exceptional provisions

·       Goods in transit

·       Cash and borrowings

2. Is the target based only on year-end numbers?

A year-end balance may not represent the rest of the year. Ask to see monthly or quarterly working capital for a sufficiently representative historical period.

3. Has seasonality been properly considered?

If sales, inventory or collections change during the year, the target should reflect the company’s operating cycle and the proposed closing date.

4. Is the same accounting policy being used throughout?

The target and the closing working capital should be calculated using consistent definitions and accounting principles. Otherwise, the comparison may not be like for like.

5. What will happen if the closing date changes?

A target appropriate for one quarter may not be suitable for another. The transaction documents should explain how the target will operate if closing moves into a different part of the seasonal cycle.

The seller’s takeaway

Normalised working capital is not merely an accounting calculation. It is part of the price negotiation.

A buyer should receive a business with enough working capital to operate normally after closing. At the same time, a seller should not suffer a price reduction because the target was calculated using an unrepresentative date, inconsistent definitions or a method that ignores seasonality.

Before agreeing to a working capital target:

1.        Analyse monthly or quarterly historical balances.

2.        Identify old, unusual and non-operating items.

3.        Understand the company’s seasonal cycle.

4.        Agree every included and excluded item.

5.        Illustrate the mechanism using the expected closing date.

6.        Ensure the Letter of Intent and definitive agreements reflect the agreed commercial methodology.

A few lines in the transaction documents can have a meaningful impact on the final consideration. Understanding those lines early can help protect the value you have spent years building.

This article is for general information and does not constitute accounting, tax, legal or transaction advice. The appropriate working capital definition and adjustment mechanism depend on the company, transaction structure and agreed documents.