When I analyze a small business acquisition, one of the first financial concepts I dig into is working capital. Early in my career, I underestimated how critical it was. I focused on revenue, profits, and multiples without fully grasping that working capital, the money a business needs to run day to day, can make or break a deal.

I learned the hard way that a profitable business on paper can still suffocate if it doesn’t have enough working capital. That’s why I now treat working capital as one of the most important parts of due diligence.

What Working Capital Really Means

Working capital is the difference between current assets and current liabilities. In simpler terms, it’s how much cash and short-term resources a business has available to cover its short-term obligations.

Current assets typically include:

• Cash
• Accounts receivable
• Inventory

Current liabilities typically include:

• Accounts payable
• Accrued expenses
• Short-term debt

Positive working capital means a business can pay its bills and operate smoothly. Negative working capital means liquidity is tight, and survival may depend on outside funding.

Why Working Capital Matters in Acquisitions

In acquisitions, working capital matters because it determines how much cash the business really needs to function after closing. If I ignore it, I risk walking into a deal where I have to inject more capital just to keep the lights on.

Working capital affects:

• Liquidity: Whether the company can cover payroll, vendors, and expenses.
• Debt service: Whether cash flow can support loan payments.
• Growth potential: Whether funds are available to seize new opportunities.
• Purchase price adjustments: Whether the seller leaves enough capital in the business at closing.

My Early Mistakes

In one acquisition, I assumed profitability equaled stability. After closing, I discovered receivables took 90 days to collect, while payables were due in 30. Suddenly, the business was always starved for cash. I had to inject capital I hadn’t budgeted for.

In another deal, I overlooked seasonal working capital swings. The business needed heavy inventory upfront each year, but I hadn’t accounted for it. The result was a painful scramble for liquidity.

Both experiences taught me to take working capital seriously.

How I Evaluate Working Capital

Today, I analyze working capital through a structured approach.

1. Historical Trends
I look at working capital over the past 12–24 months. Has it been stable, growing, or shrinking? Large fluctuations often signal risk.

2. Receivables and Payables
I study collection cycles for receivables and payment terms for payables. If customers pay late and vendors demand quick payment, cash gaps appear.

3. Inventory Levels
I assess whether inventory is fast-moving or slow-moving. Excess inventory ties up capital unnecessarily.

4. Seasonality
Some businesses require more working capital at certain times of the year. I model those fluctuations to ensure I won’t be surprised.

5. Normalized Working Capital
I calculate the “normalized” level of working capital needed for smooth operations. This number becomes my benchmark for negotiations.

How I Negotiate Working Capital in Deals

When negotiating purchase agreements, I set a target working capital level that the seller must deliver at closing. If actual working capital is below target, the purchase price is adjusted downward.

This protects me from buying a business that’s underfunded on day one.

Mistakes Sellers Make

I’ve noticed that some sellers strip out working capital before closing to boost their payout. They may drain cash or delay payables. If I don’t protect myself with a target working capital clause, I inherit the problem.

That’s why I insist on clear language in agreements.

Why Lenders Care About Working Capital

Banks and lenders scrutinize working capital closely. They know that businesses with weak liquidity are more likely to default. In many cases, lenders require covenants tied to working capital levels.

This is another reason I evaluate it carefully it affects financing terms as well as operational health.

How I Strengthen Working Capital Post-Acquisition

If I buy a business with weak working capital, I take steps to strengthen it:

• Improve collections on receivables
• Negotiate longer payment terms with vendors
• Streamline inventory to reduce excess stock
• Build a cash buffer through disciplined reserves

Even modest improvements can free up significant liquidity.

Why Working Capital Affects Valuation

Businesses with strong, stable working capital are more valuable because they’re less risky. Buyers like me will pay more for companies that don’t require constant cash injections.

Conversely, businesses with poor working capital management deserve discounted valuations because the buyer must fund liquidity gaps.

Final Thoughts

I’ve learned that working capital is one of the most important but often overlooked elements of small business acquisitions. It determines whether a business thrives or struggles post-close.

That’s why I study historical trends, normalize requirements, negotiate purchase price protections, and plan for improvements. Because at the end of the day, profitability on paper doesn’t matter if cash isn’t available to run the business.

I continue sharing my acquisition frameworks, lessons, and strategies at DrConnorRobertson.com, where I document the playbook I’ve built deal by deal.