Purchase Price Adjustments: Net Working Capital Mechanisms and Timing

Introduction: The Invisible Tug-of-War in M&A Deals

Behind the closing bell of every acquisition is a lesser-known but highly consequential negotiation: the purchase price adjustment (PPA). It is not about haggling over the top-line number. It is about reconciling the number with economic reality at closing. And that reality is usually defined through net working capital (NWC) targets and timing.

Why Net Working Capital Matters

NWC adjustments are designed to ensure that a business is delivered with a normalized level of short-term operating assets and liabilities. If working capital is higher than target at closing, the seller gets more. If it is lower, the buyer gets compensated. This mechanism ensures that cash-like value and operational solvency are fairly handed off.

In a manufacturing acquisition, the seller delayed payments to suppliers in the last weeks before closing. This inflated cash and deflated payables. The NWC adjustment later corrected this, reducing the purchase price by $2.4 million.

Defining the Target: Art or Science?

Setting the NWC target is not a formulaic exercise. It requires:

• Analysis of trailing 12-month averages
• Seasonal adjustments
• Exclusion of non-recurring items
• Consideration of one-time revenue spikes or dips

We once used a rolling average of trailing 6 months, excluding a one-off inventory buy. It helped avoid an overpayment that would have occurred had we simply taken the most recent month as indicative.

Timing and Mechanics: When the Tug Begins

The adjustment process typically involves:

• Setting a target at signing
• Preparing a closing statement post-close
• Buyer review and challenge window
• Dispute resolution mechanism

Buyers usually have 60 to 90 days to contest the seller’s closing statement. The clock starts ticking fast, so finance teams must be ready.

Common Pitfalls and How to Avoid Them

Pitfall 1: Undefined accounting principles. Solution: Agree on GAAP vs. consistent application upfront. Pitfall 2: Excluded liabilities. Solution: Define which liabilities (e.g., bonuses, taxes) are included in NWC. Pitfall 3: Sloppy data handoff. Solution: Conduct mock close pre-signing to identify gaps.

We once faced a $900K swing because the seller excluded accrued bonuses from liabilities. The PPA process caught it, but not without delay.

Escrows and Disputes: Containment Strategy

Escrows tied to NWC adjustments reduce dispute escalation. We routinely escrow 5–10% of purchase price pending PPA finalization. In one deal, we tied escrow release to auditor sign-off, which sped up resolution.

Best Practices for CFOs

• Involve operations and AR/AP teams early in NWC modeling
• Create a playbook with templates for working capital schedules
• Insist on a clear dispute resolution clause in the SPA
• Stress-test seasonality and AR timing assumptions

Conclusion: A Technical Clause with Strategic Consequences

The PPA is often dismissed as accounting minutiae. But in fast-moving M&A, it is the difference between paying for growth and paying for manipulation. A well-structured adjustment clause protects buyers, disciplines sellers, and aligns both to the truth of closing-day economics.

Insight

The purchase price is never really final until the net working capital adjustment is complete. That has been a hard-earned lesson from dozens of deals. Purchase price adjustments tied to working capital are a CFO’s quiet battleground. They are rarely glamorous but often decisive. A misstep here can turn a strategically sound acquisition into a financial disappointment.

When I began working on M&A transactions, I saw the PPA clause as back-office detail. But over time, I have learned that it is a precision tool—part calculator, part lie detector. It tells you whether the financial statements reflect operational integrity or whether there’s an endgame shuffle happening behind the scenes.

Let me take you into a live deal to explain. We were acquiring a mid-sized software company with $120 million in annual revenue. The purchase price was $210 million. Everything was crisp—customer metrics, retention rates, margin growth. But something about the working capital profile caught my eye. Days payables were unusually stretched in the final two months. After a deeper dive, we realized the target had paused vendor payments to boost cash on the balance sheet and show a healthier profile. Had we not structured the NWC adjustment with a trailing 6-month average, we would have paid an extra $3.2 million at closing. That clause, embedded in a spreadsheet model weeks before, paid for itself ten times over.

In another case, the seller wanted the target to be based on the most recent month, arguing it reflected their latest operating rhythm. Our analysis showed that month had an abnormal inventory burn tied to a promotional campaign. If we had agreed to their framing, we would have borne the cost of a one-time inventory expense as if it were baseline. Instead, we negotiated a normalized trailing twelve-month average, with a downward adjustment for seasonal troughs. That move saved us nearly $1.5 million.

Defining working capital is part legal drafting and part operational anthropology. It is not enough to say you want to adjust based on net working capital. You must define what is included—prepaids, deferred revenue, payroll accruals, rebates, customer deposits. In one deal, we learned the hard way when the seller excluded accrued bonuses from the working capital target without disclosing it. That created a $900,000 discrepancy post-close, which took months of legal back-and-forth to resolve.

One of the biggest sources of friction is accounting basis. Are we using GAAP? Modified cash basis? Seller’s historical policy? We now mandate a clear clause that specifies accounting standards, as applied consistently with the past 12 months. Any deviation must be disclosed in the purchase agreement. This stops surprises where the seller switches methods in the closing statement to game the number.

Timing is another overlooked factor. Most working capital adjustments occur 60 to 90 days post-close. But the buyer has to prepare a closing statement within a matter of weeks. In high-velocity deals, finance teams are already buried with integration. That is why we now include a mock close in our diligence process. Before signing, we simulate the closing statement with data available and identify where gaps or judgment calls will emerge.

We also encourage our deal teams to pre-negotiate a dispute resolution mechanism. That includes the accounting firm to be used for arbitration, the scope of its review, and the timeline for resolution. In one deal, a lack of clarity on these terms led to a nine-month escrow lock-up. After that experience, we require the inclusion of an accounting arbitration clause and define the trigger thresholds.

From a financial modeling perspective, the PPA also affects purchase price allocation, goodwill calculation, and deferred tax setup. It is not just a line item in the SPA. It is embedded in post-close reporting, audit compliance, and integration forecasts. Misestimating the final working capital number can affect the buyer’s cash flow and leverage ratios in the quarter after closing.

Sellers, understandably, try to game this system. We see common maneuvers like slowing down payables, accelerating receivables, cutting inventory, or holding back payroll accruals. That is why I always run sensitivity models showing the range of potential adjustments based on historical variability. These models feed directly into our negotiation strategy. If the working capital adjustment could swing by $3 million, we make sure the escrow and price reflect that.

Escrows are a smart way to manage this uncertainty. In most deals, we escrow 5 to 10 percent of the purchase price until the PPA is finalized. In one case, we tied the escrow release to auditor sign-off on the closing statement. This aligned everyone’s incentive to finish the review on time and in good faith.

Over the years, we have built an internal playbook for working capital adjustments. It includes templates for modeling, sample clauses for contracts, red flags in diligence, and roles for post-close execution. We train our finance managers in this playbook so that they can support deal execution without reinventing the wheel.

Perhaps the most important cultural insight I can share is this: buyers and sellers come to deals with different notions of value. For the seller, the company’s headline valuation is a statement of legacy and achievement. For the buyer, it is a starting point. Purchase price adjustments reconcile these worldviews not emotionally, but mathematically. They allow both parties to walk away knowing the deal was fair—not just in intention, but in fact.

So while it might be tempting to treat the PPA clause as boilerplate, I have learned never to do so. It is one of the few places where the operational heartbeat of a company shows up in the legal contract. And as with most things in finance, the truth lives in the footnotes, the schedules, and the assumptions.

For any CFO preparing to buy or sell a business, I offer this advice: Treat the purchase price adjustment with the same rigor you would apply to revenue recognition or deferred tax accounting. It is not a postscript to the deal. It is the calibration mechanism that ensures what you paid matches what you got.

Disclaimer: This article is for informational purposes only and does not constitute legal, tax, or financial advice. Always consult qualified advisors before structuring M&A agreements or purchase price adjustments.