Quick answer: A net working capital (NWC) peg, also called the working-capital target, is the level of operating working capital the buyer expects the business to have at completion. If actual working capital at closing is above the peg, the price usually goes up; if it is below, the price usually goes down. The peg is normally based on the business’s average working capital over a recent period, adjusted for seasonality and one-off items.
Buyers price a business on the assumption that it comes with enough working capital to keep trading normally. The peg turns that assumption into a number, and the completion mechanism turns the gap between the peg and the actual closing figure into a price adjustment.
What the peg is for
Without a peg, a seller could collect receivables early, delay supplier payments or run down inventory before completion, take the extra cash, and leave the buyer to fund the shortfall. The peg protects against that. It also protects the seller: if the business is handed over with more working capital than normal, the seller is paid for it.
Not every deal uses a peg. Some use a locked-box mechanism, where the price is fixed by reference to a historical balance sheet and value leakage after that date is prohibited instead. The right mechanism is a commercial and legal decision for the parties and their advisers.
Defining net working capital for the deal
In a transaction, NWC is usually a narrower measure than the accounting definition of current assets less current liabilities. It aims to capture the capital needed to run day-to-day operations.
- Usually included: trade receivables, inventory, prepayments, trade payables, operating accruals and deferred income linked to normal trading.
- Usually excluded: cash, borrowings and other items treated as net debt or debt-like; income tax balances; balances with shareholders or related parties; and transaction-related liabilities.
The exact list is negotiated and written into the transaction documents. What matters most is consistency: an item should sit in working capital or in net debt, never both and never neither, and it should be treated the same way in the peg calculation and the closing statement.
How the peg is usually calculated
- Build monthly NWC for a reference period, commonly the last twelve months, using the agreed definition.
- Normalise each month for one-off items, accounting errors, unusual timing and items that will not continue after the deal.
- Look at seasonality. If working capital swings through the year, a simple average may be misleading for the expected completion month.
- Choose the measure (often an average of normalised months) and document why it reflects a normal level of working capital.
- Check the result against business drivers such as revenue, debtor days, creditor days and inventory days.
Illustrative example
The figures below are invented to show the mechanics. They do not describe any client or engagement.
| Step | Amount (illustrative) |
|---|---|
| Average monthly NWC, last 12 months, as reported | 1,050 |
| Remove a one-off customer prepayment in month 9 | +30 |
| Agreed peg (normalised average) | 1,080 |
| Actual NWC in the closing statement | 1,020 |
| Shortfall against peg: price reduced by | 60 |
Removing a customer prepayment increases NWC because deferred income is a liability. That is why each normalising item needs a clear explanation.
How the closing true-up works
The buyer or seller prepares a closing statement after completion, using the same definitions and accounting policies set out in the agreement. The difference between closing NWC and the peg adjusts the price, sometimes only once it exceeds an agreed threshold or outside an agreed range. The agreement usually sets a timetable for preparing, reviewing and disputing the statement, often ending with an independent expert if the parties cannot agree.
Where working-capital disputes usually start
- Accounting policies used at closing that differ from those used to set the peg.
- Items such as accrued bonuses, customer deposits or provisions treated as working capital in one calculation and as debt in another.
- Cut-off differences around the completion date.
- A peg based on an average that ignored seasonality, compared with a closing date at a seasonal high or low.
- Vague definitions in the agreement that leave room for both sides’ interpretation.
Working-capital peg checklist
- Monthly NWC built for the full reference period and reconciled to the balance sheet.
- Definition agreed and consistent with the net-debt schedule.
- Each normalisation documented with evidence.
- Seasonality reviewed against the expected completion date.
- Accounting policies for the closing statement written down and matched to the peg.
- Illustrative closing statement prepared and reviewed by both finance and legal advisers.
Support for working-capital analysis
Working-capital analysis is detailed, monthly work that sits alongside the earnings and net-debt workstreams. Plus One supports deal teams with financial due diligence in India and provides outsourced FDD and QoE analysis for firms abroad. See also the financial due diligence checklist and how an FDD databook is structured. This guide is general information; the transaction mechanism and definitions should be agreed with your legal and financial advisers.
Frequently asked questions
How is the net working capital peg calculated?
Build monthly NWC for a reference period, often the last twelve months, using the deal definition. Normalise each month for one-off and unusual items, check seasonality against the expected completion month, then usually take an average of the normalised months.
Is the NWC peg the same as the working-capital target?
Yes. Peg, target and normalised working capital are commonly used for the same agreed level of operating working capital that the closing figure is compared with.
Is cash included in net working capital?
Usually not. Cash, borrowings and other debt-like items are normally dealt with in net debt, so that each item is counted once and in only one place.
What happens if closing working capital is below the peg?
The purchase price is usually reduced by the shortfall, sometimes only beyond an agreed threshold or outside a range. If closing working capital is above the peg, the price usually goes up.
Finance and advisory team based in Gurugram, India, working since 1992. This guide is general information and does not constitute transaction, accounting, tax or legal advice.