Working Capital Peg and Proof of Cash: A Buyer’s Guide

What is a working capital peg meant to achieve?

A working capital peg is the benchmark against which working capital at completion is compared. It makes sure the buyer receives a business with the normal level of operating funding assumed in the price. It is not the company’s bank balance, and it does not promise that no further funding will ever be needed.

A typical definition includes trade receivables and inventory, less trade payables and specified operating accruals. Other balances may be included or excluded depending on the business. Cash, borrowings and items treated as debt-like are usually excluded, but the agreement must say so explicitly to avoid later disputes.

The commercial aim is to prevent a price based on one level of working capital while a different level is delivered. Collecting debts early, delaying supplier payments or running down stock before completion can change the balance without reflecting normal trading. Due diligence should identify such movements and their causes.

How is a trailing 12-month average used?

A trailing 12-month average of monthly working capital is the usual starting point for the peg, because it covers a full trading cycle. It should not be applied mechanically. Check that those months reflect the business being bought, consistent accounting policies, normal trading conditions and the expected completion date.

Calculate working capital for each month using the proposed contractual definition, and reconcile balances to the ledgers. Check that monthly accounts include proper provisions and accruals; a year-end audit adjustment may reveal errors that affect earlier months too. Averaging inconsistent numbers does not remove the inconsistency.

Consider growth, decline, acquisitions, discontinued activities and changes in customer or supplier terms. In a fast-growing business a historical average may understate the funding needed; after a permanent change it may overstate it. Comparing working capital with sales, purchases and stock usage helps judge whether the average is representative.

How should seasonality and unusual items affect the peg?

Seasonality and normalisation are separate adjustments. Seasonality reflects regular swings within the trading year, while normalisation removes balances that do not reflect normal operations. The proposed peg should explain both clearly, and every adjustment should be supported by evidence rather than chosen to favour one side.

For a seasonal business, stock may build before peak sales and receivables rise afterwards, so a full-year average can differ from the level expected at a particular completion date. Compare the same months in earlier years and consider a peg for the completion month or another clearly agreed mechanism.

Normalisation may deal with very old receivables, obsolete stock, missing accruals or unusual supplier balances. Check whether the same issue already appears in the EBITDA adjustments or the debt bridge. An omitted expense and its unpaid liability can affect different parts of the price, and the agreement must avoid double counting.

How does the completion true-up work?

The share purchase agreement defines which balances are included, which policies apply and how completion working capital is calculated. The true-up then compares that figure with the peg and adjusts the price. A strong historical analysis cannot fix vague drafting or different definitions between the peg and the completion accounts.

As an illustration in index units rather than currency, assume a peg of 100 and an estimated completion balance of 104. If the agreement adjusts unit for unit, the estimate adds four units to the price at completion. If the final agreed balance is 101, the true-up reverses three of those units afterwards.

The example assumes an estimate at completion followed by final accounts; other structures, such as a locked box, work differently. Set out preparation deadlines, access to records, review periods and dispute resolution. Specify the order of accounting policies and list debt-like exclusions, so no liability appears in both working capital and net debt.

What does a bank-to-books proof of cash involve?

Proof of cash reconciles opening cash, receipts, payments and closing cash between bank statements and the accounting records for an agreed period. It investigates differences instead of assuming deposits equal sales or payments equal expenses. Its usefulness depends on including every bank account and classifying transactions accurately.

Start by listing every bank account, including payment gateways and accounts outside the main bank. Reconcile opening and closing balances and explain outstanding items. Classify receipts into customer collections, loans, owner funding, refunds and other categories, and identify transfers between accounts so they do not inflate totals.

Analyse payments by suppliers, payroll, taxes, capital expenditure, loan repayments, distributions and transfers. Timing differences from uncleared cheques and settlement delays are normal, but unexplained differences need follow-up. Link customer receipts to receivables and sales periods. A proof of cash can reveal missing entries without proving every transaction is commercially genuine.

Why do buyers and lenders ask for both analyses?

Buyers use working capital analysis to understand operating funding and price mechanics, and proof of cash to judge whether the cash records are reliable and earnings convert into cash. Lenders use both to assess repayment capacity. Neither analysis alone shows that the acquired business can service its acquisition debt.

A business with positive EBITDA can still consume cash through stock growth, slow collections, capital spending and tax payments. Strong receipts may also reflect collection of old debts or a one-off fall in working capital. Presenting these movements separately helps the buyer distinguish recurring performance from a temporary release of cash.

Agree deliverables such as monthly working capital schedules, a definition bridge, cash reconciliations and a list of open items, and state which accounts and periods were tested. Where SBA or other lender financing is involved, confirm the lender’s specific information requirements rather than assuming a standard package satisfies them.

What are common sources of dispute after completion?

Most post-completion disputes about working capital arise from unclear definitions, changes in accounting policies and balances that were not addressed when the peg was set. Clear drafting, a worked example in the agreement and consistent policies between the peg and the completion accounts prevent most of them before they start.

Typical disputes concern provisions for doubtful debts or obsolete stock, cut-off of sales and purchases around the completion date, accruals for bonuses or leave, and whether particular balances belong in working capital or net debt. Each of these should be discussed and documented during diligence rather than left for the completion accounts.

Including an illustrative calculation in the agreement, based on a recent month and using the agreed definitions, helps both sides apply the mechanism the same way. It also exposes ambiguous wording before signing, when it is far easier to correct than after the buyer has taken control.

Agree a practical dispute process: timelines for preparing and reviewing completion accounts, access to records and staff, and referral of unresolved items to an independent accountant acting as an expert. A clear process limits the cost and delay of resolving disagreements about the final adjustment.

Finally, keep the working papers used to set the peg. If a dispute arises, a clear record of the monthly calculations, adjustments and reasons agreed during negotiation is the most persuasive evidence of what the parties intended. Store it with the signed agreement and the completion accounts so it is easy to find later.

Which balances need explicit treatment in the peg?