Working Capital Adjustments in Australian Business Sales: What Sellers Must Know

You've negotiated an enterprise value. The sale and purchase agreement is signed. Settlement is weeks away. Then your lawyer mentions "working capital adjustments" — and suddenly your $5 million sale price might deliver $4.7 million, or $5.3 million, depending on the balance sheet at completion.

For most Australian SME sellers, working capital adjustments are the least understood — and most contested — mechanism in business sales. They're also non-negotiable: buyers won't acquire a business without them, because they protect against balance sheet manipulation between signing and settlement.

This guide explains how working capital adjustments work, why they exist, how to negotiate them fairly, and how to avoid the post-closing disputes that plague 30-40% of Australian M&A transactions.

What Is Working Capital?

Working capital is the operating liquidity available to a business — the cash and near-cash assets needed to fund day-to-day operations.

The formula:
Working Capital = Current Assets - Current Liabilities

Current assets typically include:

• Cash and cash equivalents
• Trade receivables (accounts receivable)
• Inventory and work-in-progress
• Prepaid expenses

Current liabilities typically include:

• Trade payables (accounts payable)
• Accrued expenses
• Deferred revenue (unearned income)
• Short-term debt (sometimes excluded — see below)

In Australian M&A, working capital is usually defined on a cash-free, debt-free basis — meaning cash and interest-bearing debt are excluded from the calculation, as they're settled separately at completion.

Why Do Working Capital Adjustments Exist?

Working capital adjustments exist to protect both buyer and seller from balance sheet changes between signing the sale agreement and settlement (typically 30-90 days later).

Without an adjustment mechanism, sellers could:

• Delay paying suppliers to inflate cash at completion
• Accelerate collections to strip receivables
• Run down inventory to generate short-term cash
• Defer expenses to improve the balance sheet appearance

Conversely, buyers want assurance that:

• The business has sufficient working capital to operate post-acquisition
• They're not inheriting depleted inventory or overdue payables
• The balance sheet reflects normal trading conditions

The adjustment mechanism ensures the buyer receives a business with working capital in line with historical norms — neither artificially inflated nor stripped of operating liquidity.

How Working Capital Adjustments Work: The Peg Mechanism

Most Australian business sale agreements use a working capital peg (also called a target or normalised working capital level).

How the Working Capital Peg Is Set

The peg is typically calculated as:

• Average of last 12 months: Most common approach — smooths seasonal variations
• Average of last 6 months: Used if recent trading is more representative
• Latest month-end: Less common — can be volatile and subject to timing manipulation
• Seasonal adjustment: For seasonal businesses, the peg might reference the same month in the prior year

What's Included (and Excluded) from Working Capital

The devil is in the definitions. Your sale agreement must specify exactly which balance sheet items are included in the working capital calculation.

Commonly Excluded Items:

• Cash and cash equivalents — settled separately as part of the cash/debt adjustment
• Interest-bearing debt — also settled separately
• Shareholder loans — typically excluded or settled outside the transaction
• Tax liabilities and refunds — often carved out to avoid double-counting with tax indemnities
• Deferred tax assets/liabilities — excluded in most SME deals

Commonly Contested Items:

• Accrued expenses: Are annual leave provisions included? What about bonuses or commissions earned but not yet paid?
• Prepaid expenses: Insurance, rent, software subscriptions — should they be normalised or excluded?
• Deferred revenue: For SaaS or subscription businesses, how is unearned income treated?
• Intercompany balances: If you're selling part of a group, intercompany receivables/payables need careful definition

The Completion Accounts Process

Here's how the adjustment typically unfolds:

1. Estimated Adjustment at Completion

On the settlement date, the seller prepares an estimated completion balance sheet showing working capital as at settlement. The purchase price is adjusted based on this estimate, and funds are transferred.

2. Final Completion Accounts (30-60 days post-settlement)

Within 30-60 days after completion, the buyer prepares the final completion accounts — a detailed balance sheet showing actual working capital at settlement.

3. Review Period (15-30 days)

The seller has 15-30 days to review the buyer's completion accounts and raise any objections.

4. Dispute Resolution (if needed)

If the parties can't agree on the final working capital figure, the dispute typically goes to:

• Independent accountant determination (most common — accountant's decision is binding)
• Expert determination (similar, but uses an industry expert rather than accountant)
• Arbitration (less common for working capital disputes)

5. Final True-Up Payment

Once the final working capital is agreed (or determined), any variance from the estimated adjustment is settled by a cash payment — either buyer pays seller, or seller refunds buyer.

Common Disputes and How to Avoid Them

1. Accounting Policy Differences

The problem: The buyer applies different accounting policies to calculate working capital than the seller used historically.

The solution: The sale agreement should specify that completion accounts must be prepared using the same accounting policies and practices as the target peg. Include this as an explicit clause.

2. Cut-Off Date Manipulation

The problem: Inventory, receivables, or payables are deliberately timed to improve the balance sheet at completion.

The solution: Include a clause requiring the seller to operate the business in the ordinary and usual course between signing and completion — no deferring expenses, accelerating collections, or delaying supplier payments.

3. Subjective Provisions and Accruals

The problem: Provisions for doubtful debts, obsolete inventory, or warranty obligations are subjective and easily manipulated.

The solution: Base provisions on historical percentages or agreed methodologies. For example: "Doubtful debt provision will be 2.5% of receivables over 90 days, consistent with FY25 audited accounts."

4. Unclear Treatment of Seasonality

The problem: Seasonal businesses have working capital that swings significantly month-to-month (e.g., retail before Christmas, construction in summer).

The solution: Use a seasonally-adjusted peg, or average multiple comparable periods. For a December completion, the peg might be the average of the prior three Decembers — not the annual average.

Negotiation Strategies for Sellers

1. Understand Your Historical Working Capital Trends

Before negotiating the peg, analyse your last 12-24 months of balance sheets. Identify:

• Seasonal patterns
• One-off events that inflated or depressed working capital
• Changes in payment terms (yours or your suppliers')

2. Negotiate Normalisation Adjustments

If your historical working capital was artificially low (e.g., you've been undercapitalised, or ran the business conservatively), push for normalisation adjustments when setting the peg.

3. Insist on a Narrow Review Period

The longer the post-completion review process, the longer your proceeds are at risk. Negotiate tight deadlines:

• Buyer must deliver completion accounts within 30 days (not 60)
• Seller has 15 days to review (not 30)
• Expert determination must be completed within 30 days of referral

4. Cap Downside Risk with a De Minimis Threshold

For smaller deals, negotiate a de minimis threshold — e.g., no adjustment unless the variance exceeds $25,000 or 5% of the peg.

This reduces transaction costs (accountants arguing over $5,000 line items) and provides certainty.

5. Consider a Locked Box Mechanism (Alternative)

If you want to avoid post-closing adjustments entirely, negotiate a locked box structure:

• Enterprise value is adjusted to a specific "locked box date" (e.g., last month-end)
• Purchase price is fixed based on that date's balance sheet
• No further adjustments occur — seller bears risk/reward between locked box date and completion

Locked boxes are more common in larger deals, but increasingly used in Australian SME sales where both parties want certainty.

Tax Treatment of Working Capital Adjustments

The tax treatment depends on whether the sale is structured as:

Share Sale

Working capital adjustments change the total sale proceeds, which affects:

• Capital gains tax: Higher proceeds = higher CGT
• CGT small business concessions: May affect eligibility thresholds

Asset Sale

The adjustment is typically allocated proportionally across asset classes (inventory, receivables, plant & equipment), which affects:

• Capital vs revenue treatment for different asset types
• GST on inventory and certain assets

Red Flags to Watch For

Be wary if the buyer's lawyer proposes:

• A peg significantly higher than your historical average — they're building in a post-closing refund
• Asymmetric adjustment rights — e.g., buyer gets refund if working capital is low, but seller doesn't get bonus if it's high
• Vague accounting policy clauses — insist on "consistent with historical policies" language
• Unlimited post-closing review period — cap it at 60 days maximum
• Buyer unilaterally determines completion accounts — ensure you have review and dispute rights

Final Thoughts

Working capital adjustments are a standard — and fair — mechanism in Australian business sales. They protect buyers from balance sheet manipulation and ensure sellers aren't penalised for delivering a well-capitalised business.

But the devil is in the details. A poorly-drafted working capital clause can turn into a six-month dispute over $50,000 — eroding goodwill, delaying handover, and burning advisory fees.

The key is specificity:

• Define working capital precisely (with a sample calculation)
• Set the peg based on normalised, representative periods
• Lock in accounting policies that match historical practice
• Agree on tight timelines for completion accounts and dispute resolution

Get it right in the sale agreement, and the post-completion adjustment becomes a mechanical process. Get it wrong, and you'll spend months arguing with accountants while your sale proceeds sit in escrow.