Thursday, March 6, 2014

Why do I leave working capital in business when I sell?



Every share based transaction will have to address the working capital discussion.
The net outcome of a sale of business transaction will typically be adjusted lower if the vendor does not leave working capital in the business. Or; the net outcome price will be higher if the vendor leaves working capital above the net working capital calculation.
"Working capital" is the money you need to support short-term operations. It is this focus on the short term that distinguishes working capital from longer-term investments in fixed assets or R&D.

Working capital is the difference between current assets and current liabilities. "Current" again refers to the fact that these items fluctuate in the short term, increasing or decreasing along with operating activities. Current assets include cash, short-term investments, accounts receivable and inventories. Current liabilities include an operating line of credit from a bank, accounts payable, the portion of long-term debt expected to be repaid within one year, and accrued liabilities such as taxes payable. All these items turn over and change in value on an ongoing basis.

To calculate the business's operating cycle, find out how long it takes to sell services or inventories and collect accounts receivable. A business with a long operating cycle should have a higher working capital requirement than one with a shorter cycle.

Profitable, growing companies need increasing amounts of working capital to support the additional investment in inventories and accounts receivable. Businesses don't go bankrupt because they are not profitable. They go bankrupt because they run out of cash and cannot meet their payment obligations as they come due.