The evaluation of the net working capital (NWC) is an important decision in the realm of mergers-and-acquisitions (M&A). Net working capital is one of the three main points in due diligence in financial matters. It plays a crucial part in ensuring a smooth transition of ownership as as the continued operational health of a business acquired.
In M&A transactions in M&A deals, due diligence on financials is a process which must be done meticulously to minimize the risk and maximise return. Net working capital is a crucial component of this process, which includes analyzing the financial aspects of the potential buyer. What is networking capital exactly and why does its significance matter?
Net working capital is the difference between the current assets and current liabilities. It is the liquid assets that a company uses to support its daily operations. Net working capital is a valuable source of information to prospective buyers on the liquidity of a company in the short-term as well as its operational efficiency.
During due diligence, the working capital of the targeted business is thoroughly examined to determine if there is enough liquidity in place to continue operations after acquisition. This examination involves a thorough study of the target’s financial account, including things like accounts receivable, inventory, accounts payable and other current financial assets and liabilities.
The direct correlation between net working capital and the future cash flows of the buyer is one of the major reasons it plays such a significant part in M&A diligence. Net working capital can be used by buyers to determine the ability of a company to meet short-term obligations, and to fund day-today operations. A high level of net working capital shows that the business is well placed to deal with short-term changes and unexpected expenses, which gives confidence in the buyer’s decision to invest.
Furthermore, net working capital serves as a barometer of effectiveness of management and operational efficiency. A business that has efficient working capital management procedures will have a more efficient supply chain, optimal inventory levels, and timely collection from customers and suppliers. All of these help improve financial performance and liquidity. Working capital levels that are too high may be a sign of poor inventory management, or a lack of policies regarding credit, both of which can cause a decline in profits.
When it comes to M&A transactions, knowing the nuances of net working capital is vital for both sellers and buyers. Sellers can enhance their appeal to buyers by maximizing networking capital. This can also help facilitate the process to be more efficient. Sellers that demonstrate good working capital management and maintain the proper balance between their both liquidity and operational requirements will have a competitive edge in negotiations.
In the opposite direction, buyers must conduct a thorough evaluation of the operating capital of their target to mitigate risks and ensure successful integration post acquisition. This means not only looking at net working capital in absolute terms, but also evaluating the composition and longevity of the asset over time. When identifying potential red flags and concerns early in the process buyers can make informed choices and negotiate changes to the deal structure or the purchase price. See more NWC peg
In the end net working capital is a cornerstone of financial due diligence in M&A transactions, playing a crucial role in assessing the liquidity of the company and its efficiency of the target company. Net working capital can help buyers and sellers navigate M&A deals without trepidation. It can increase the value and ensure long-term success. Net working capital is the beating core of every transaction. It helps all parties towards a mutually profitable outcome.
