Net Working Capital Adjustment in M&A: How the Peg Works

A net working capital adjustment in M&A is a contractual mechanism that changes the amount paid for a business based on whether the seller delivers more or less working capital than an agreed target at closing. That target is called the working capital peg. The adjustment moves dollar-for-dollar: if actual closing working capital lands $300,000 below the peg, the purchase price falls by $300,000. The mechanism protects buyers from receiving a business stripped of the resources it needs to operate and protects sellers when they deliver more than required.

Working capital adjustments now appear in more than 90 percent of private-target transactions. According to SRS Acquiom’s 2025 Working Capital Purchase Price Adjustment Study, which analyzed more than 1,200 private-target acquisitions with over $298 billion in finalized adjustments, purchase price adjustments of this type have become nearly ubiquitous, appearing in more than 90 percent of private-target deals and even higher shares of private-equity-backed deals. Understanding how the net working capital adjustment works is essential for sellers, buyers, and their advisors because the peg can shift real dollars well after the headline price is set.

What the Net Working Capital Adjustment Is and Why It Matters

Most middle-market acquisitions are structured on a “cash-free, debt-free” basis. The seller keeps the cash on hand and pays off outstanding debt at closing. In exchange, the seller is expected to leave behind a normal, operational level of working capital so the business can function on day one without the buyer injecting fresh funds.

Net working capital (NWC) in a deal context is generally current operating assets minus current operating liabilities. The asset side typically includes accounts receivable, inventory, and prepaid expenses. The liability side typically includes accounts payable, accrued expenses, and other short-term operating obligations. The exact line items are always defined in the purchase agreement, because the deal definition frequently differs from the standard accounting definition.

Without a working capital peg, a seller could accelerate receivable collections, delay vendor payments, and run down inventory before closing, handing the buyer a business that looks fine on paper but cannot sustain normal operations. The peg eliminates that incentive by setting a fixed target and adjusting price for any deviation from it. The adjustment turns those cash-extraction maneuvers into a wash at best, and sophisticated buyers will identify the pattern during diligence.

How the Working Capital Peg Is Set

Trailing-Twelve-Month Average

The most common method is to base the working capital peg on a trailing-twelve-month (TTM) average of the target’s month-end net working capital. Advisors pull the working capital balance at each of the last twelve month-ends and average them. Using twelve months smooths seasonal swings, which matters for businesses whose receivables or inventory fluctuate significantly across the year. Some deals use a shorter six-month window when the business is growing quickly and older data no longer reflects current operating norms.

Normalization Adjustments

The raw average is rarely used without adjustment. Both sides work through a normalization process to remove one-time distortions and items that do not belong in an ongoing operations picture. Common normalizations include:

• Removing non-recurring receivables or payables tied to unusual events
• Excluding balances that will not transfer under the deal terms
• Adjusting for known seasonality when the closing date falls at a high or low point in the cycle
• Writing off stale or uncollectible receivables and obsolete inventory

Consider a simplified hypothetical. A regional manufacturer’s month-end NWC averages $2.4 million over the past year, but three of those months were inflated by a large one-time receivable that has already been collected and will not recur. After removing that item, the normalized TTM average settles at $2.1 million. The parties agree on a peg of $2.1 million, and that figure becomes the benchmark against which actual closing working capital is measured.

The quality of underlying financial data matters enormously here. A quality of earnings analysis reviews the target’s monthly results with the same rigor applied to EBITDA, producing the reliable historical data that supports a defensible peg. When both sides trust the monthly figures, negotiating the peg is far smoother.

What Is Included and Excluded From the NWC Definition

The working capital definition in the purchase agreement is negotiated line by line, and small wording choices can move significant money. The general principle is to capture operating current assets and operating current liabilities while excluding anything handled elsewhere in the deal.

Cash is almost always excluded because the deal is structured cash-free, and cash is swept by the seller at closing. Including it in working capital would double-count it. Interest-bearing debt is also excluded, since debt is settled separately.

Items frequently debated as “debt-like” rather than working capital include:

• Deferred revenue
• Customer deposits
• Accrued bonuses
• Unpaid taxes
• Earned-but-unused vacation accruals

Where these items land can materially change the NWC calculation and, by extension, the purchase price. The definition also specifies which accounting standard controls. Agreements typically require that working capital be calculated in accordance with generally accepted accounting principles (GAAP) applied consistently with the target’s historical practices, with the agreement specifying which governs if the two conflict. The AICPA’s guidance on accounting and financial reporting underpins how these figures are calculated and, when disputes arise, how they are resolved.

A typical NWC definition looks like this in practice:

• Included assets: accounts receivable (net of reserves), inventory, prepaid expenses, other operating current assets
• Included liabilities: accounts payable, accrued operating expenses, other short-term operating liabilities
• Excluded from both sides: cash and cash equivalents, interest-bearing debt, deferred taxes, and any item classified as debt-like or addressed by a separate purchase price adjustment

The Closing-Date Estimate and the Post-Closing True-Up

Working capital cannot be measured precisely on the closing date because the books for the final period have not yet been closed. To bridge that gap, the seller delivers an estimated closing statement shortly before or on the closing date showing a good-faith estimate of NWC as of closing. The purchase price paid at closing is adjusted up or down based on how that estimate compares to the peg.

How the True-Up Works

After closing, the buyer prepares an actual closing statement using finalized numbers. This is the true-up. The buyer is typically required to deliver the post-closing statement within 60 to 90 days after closing, giving enough time to close the books and complete the accounting. The seller then has a review period, commonly 30 days, to accept the statement or deliver a written objection. Any undisputed amounts are settled promptly, and disputed line items move to a negotiation period.

If the parties cannot resolve disputed items, the purchase agreement almost always directs them to an independent accounting firm whose determination is binding on both sides. This mechanism keeps working capital disagreements out of court and gives both parties a neutral referee. Careful drafting of the definition, the accounting policies to be applied, and a sample calculation attached as a schedule to the agreement significantly reduces the odds of a dispute reaching that stage.

A Concrete Timeline Example

A deal closes on September 30 with an estimated closing NWC of $2.25 million against a $2.1 million peg, so the buyer pays $150,000 more at closing to account for the excess. Seventy-five days later the buyer’s finalized post-closing statement shows actual closing NWC was $1.95 million. Because actual NWC is $150,000 below the peg rather than above it, the seller must return the $150,000 overpayment from closing plus fund the $150,000 shortfall below the peg, for a total true-up payment of $300,000 back to the buyer.

How the Net Working Capital Target Moves the Purchase Price

The core mechanic is straightforward: the purchase price moves dollar-for-dollar with the difference between actual closing working capital and the net working capital target. There is no rounding, and most deals have no floor or collar unless the parties specifically negotiate one.

Two scenarios against a $2.1 million peg illustrate this clearly:

• Actual closing NWC of $2.35 million: working capital exceeded the peg by $250,000, so the purchase price increases by $250,000 in the seller’s favor.
• Actual closing NWC of $1.85 million: working capital fell short of the peg by $250,000, so the purchase price decreases by $250,000 and the seller funds that gap.

The enterprise value used to price the business never changes in either scenario. Only the working capital adjustment moves.

This dollar-for-dollar mechanics explains why deliberately draining working capital before closing backfires. Aggressively collecting receivables or stretching vendor payments to pull cash out of the business simply lowers closing NWC and triggers an equal price reduction. Diligence teams are trained to spot these patterns in the aging schedules and payables ledgers.

Because the peg can swing hundreds of thousands of dollars in either direction, it warrants careful attention at letter-of-intent stage, not as a last-minute item in the final purchase agreement. Engaging transaction advisory support before signing a letter of intent helps sellers establish a defensible peg, structure a fair working capital definition, and avoid surprises at the true-up. It also ensures the accounting policies written into the agreement match the policies actually used to prepare historical financials, which is one of the most common sources of post-closing disputes.

For buyers, the same diligence investment reduces overpayment risk. A thorough review of the target’s monthly working capital history, normalized properly, produces a peg that reflects economic reality rather than an artificially favorable snapshot. Modus’s audit and assurance practice supports transaction diligence with the same source-linked, documented approach applied to audit engagements.

Related reading: Quality of Earnings Reports Explained

Frequently Asked Questions

How does a net working capital adjustment work in M&A?

A net working capital adjustment compares actual NWC delivered at closing with a pre-agreed target called the peg. If actual NWC exceeds the peg, the buyer pays the seller the difference. If actual NWC falls short, the seller pays the buyer. The adjustment is dollar-for-dollar and is finalized through a post-closing true-up process that reconciles the estimated figures used at closing against the finalized numbers.

What is the difference between the working capital peg and the working capital adjustment?

The peg is the fixed target level of net working capital agreed in the purchase agreement. The adjustment is the dollar amount by which the purchase price changes based on how actual closing NWC compares to that peg. The peg is the benchmark; the adjustment is the result of measuring against it.

Why is cash excluded from net working capital in a deal?

Most acquisitions are structured on a cash-free, debt-free basis, meaning the seller retains the cash on hand and pays off outstanding debt at closing. Cash is handled as a separate deal item, so including it in working capital would double-count it. The NWC definition focuses on operating items, such as receivables, inventory, and payables, that the business needs to run.

How long after closing does the working capital true-up happen?

The buyer typically delivers its post-closing statement within 60 to 90 days after closing, once the books for the final period are finalized. The seller then has a review period, often 30 days, to accept the statement or raise objections. If a dispute remains after a negotiation period, the agreement typically requires both parties to submit it to an independent accounting firm for a binding determination.

Can a seller reduce the working capital adjustment risk before going to market?

Yes. Sellers who engage transaction advisory support early can model their historical working capital, identify normalization items, and propose a peg supported by clean documentation. This reduces the chance of a surprise true-up and strengthens the seller’s position if the buyer challenges specific line items post-closing. A quality of earnings analysis, which reviews monthly results and working capital trends, is the standard preparation step.

What happens if the parties disagree on the post-closing NWC calculation?

Undisputed amounts are settled according to the agreement’s payment mechanics. Disputed line items go through a negotiation period, and if unresolved, the dispute is submitted to an independent accounting firm designated in the purchase agreement. That firm acts as an expert, not an arbitrator, and its determination on the disputed items is binding on both parties. This process keeps working capital disputes out of litigation.