M&A Impact on Working Capital Benchmarks

Q: How do working capital benchmarks in specific industries impact M&A deals?

Industry-specific working capital benchmarks are key in mergers and acquisitions, providing a clear framework for assessing a target company's financial health. These benchmarks establish the expected working capital levels that must be delivered at closing, which can directly influence the purchase price. For instance, if the actual working capital falls short or exceeds the agreed-upon target, adjustments to the purchase price may follow. By analyzing these benchmarks, buyers gain insight into the target company's operational liquidity and cash flow requirements. This helps ensure the business can maintain its operations after the acquisition without needing immediate additional funding. Agreeing on these financial metrics not only simplifies negotiations but also lays the groundwork for a smoother transition and a more seamless integration once the deal is completed.

Mergers and acquisitions (M&A) can significantly affect working capital benchmarks, which are crucial for deal negotiations and smooth post-merger operations. Here's what you need to know:

Working capital adjustments directly impact the purchase price: Surpluses increase it, while deficits lower it.
A "working capital peg" is set based on historical averages: This ensures fairness and aligns buyer and seller expectations.
Industry-specific benchmarks vary: For example, software companies often have negative working capital, while construction businesses require higher levels due to project-based operations.
Key adjustments during M&A: Financial data is normalized through definitional, due diligence, and pro forma adjustments to ensure accuracy.
Post-merger integration is critical: Aligning financial systems, managing cash flow, and monitoring metrics like receivables turnover and inventory levels are essential for long-term success.

Quick Tip: Use technology for real-time financial tracking and foster collaboration across departments to optimize working capital during and after M&A transactions.

For a deeper dive into strategies, challenges, and industry-specific examples, explore the full article.

What Changes Working Capital Benchmarks During M&A

Several factors reshape working capital benchmarks during mergers and acquisitions (M&A), playing a key role in negotiations between buyers and sellers.

Adjusting Financial Data for Accuracy

To establish accurate benchmarks, historical financial data often needs to be adjusted. These adjustments ensure a fair and reliable working capital peg, which is crucial in M&A deals. Here are the three main types of adjustments:

Definitional adjustments: These align the working capital calculation with the cash-free, debt-free nature of M&A transactions. Items like cash balances, lines of credit, and accrued interest are excluded from the net working capital calculation.
Due diligence adjustments: These address irregularities or inconsistencies discovered during the review of trial balances and accounting practices. For instance, if a company hasn’t consistently accrued for payroll or bonuses, these adjustments ensure such items are properly accounted for in the benchmark.
Pro forma adjustments: These apply retroactively to reflect changes, such as the addition of new product lines or operational shifts, across prior balance sheet periods. This approach provides a clearer view of working capital under consistent conditions.

By normalizing the financial data, these adjustments create a working capital peg based on the average normalized net working capital over the trailing twelve months. This peg becomes the foundation for calculating the purchase price and drafting clear purchase agreements.

How Purchase Agreements Affect Working Capital

Once the financial data is adjusted, purchase agreements solidify the working capital benchmarks, directly influencing the transaction’s financial outcomes. Here’s how it works:

If the net working capital at closing exceeds the peg, the buyer increases the purchase price by the difference. For example, if the closing working capital is $22,500,000 and the peg is $20,500,000, the buyer adds $2,000,000 to the purchase price. On the other hand, if the closing working capital falls short - say, $18,500,000 against the same peg - the seller owes the buyer $2,000,000, reducing the purchase price.

"The working capital adjustment is not meant to be a way for an acquirer to get more funds out of the seller - it's a protection to ensure a normal historical level of working capital is available for the acquirer to operate the Company post-closing."
– Ryan McCaslin, CPA, CIA, CEPA

This direct, dollar-for-dollar impact on the purchase price highlights why working capital calculations often become a source of contention post-closing. Precision and transparency are critical to avoiding disputes.

Working Capital Differences by Industry

Industry-specific factors significantly influence working capital benchmarks, reflecting the unique operating models and financial structures of different sectors. Here’s how working capital benchmarks vary by industry:

Software businesses: With low working capital needs, these companies often operate with negative working capital due to their asset-light models. For example, a software company generating $10 million in revenue might show –$300,000 in working capital because subscription payments are received upfront, creating deferred revenue liabilities that surpass minimal inventory and receivables.
Consumer products businesses: These companies typically have moderate working capital intensity. A consumer products company with $10 million in revenue might maintain $600,000 in working capital, driven by higher inventory levels and accounts payable balances. On average, non-cash working capital balances in this sector are about 8.5% of sales.
Construction businesses: Known for high working capital intensity, construction companies often require substantial working capital due to project-based operations and extended payment cycles. For instance, a construction company with $10 million in revenue might need $1,600,000 in working capital to manage large accounts receivable and seasonal cash flow fluctuations.

Industry	Revenue Example	Working Capital	Key Drivers
Software	$10M	–$300,000	Deferred revenue, minimal inventory
Consumer Products	$10M	$600,000	Inventory, accounts payable
Construction	$10M	$1,600,000	Long project cycles, seasonality

"If the subject company outperforms the industry benchmarks, it often warrants a higher multiple. Conversely, a lower multiple is typically necessary if the subject company performs poorly relative to industry benchmarks."
– BerryDunn

Understanding these industry-specific variations helps buyers and sellers set realistic working capital targets. Analyzing historical trends and factoring in seasonal patterns can lead to better negotiation outcomes and smoother transactions. Companies that align their strategies with their industry’s working capital dynamics are more likely to achieve favorable results in M&A deals.

How to Improve Working Capital During M&A

Effective working capital management is a cornerstone of successful M&A transactions. By focusing on cash flow, leveraging technology, and fostering collaboration, companies can enhance their financial position and operational efficiency during this critical process.

Improving Cash Flow and Available Funds

Strengthening cash flow starts with balancing inflows and outflows. Here are some practical steps companies can take to improve their working capital:

Speed up collections: Encourage faster payments by offering early payment discounts and digitizing invoicing processes to reduce delays.
Negotiate better payment terms: Work with suppliers to secure more favorable terms. Using electronic workflows and payment systems can streamline processes and build stronger supplier relationships.
Optimize inventory management: Use demand forecasting to maintain the right inventory levels, avoiding overstocking or shortages.
Plan cash flow effectively: Accurate cash flow forecasts help manage integration costs and operational needs. Short-term financing options, such as lines of credit or invoice financing, can also provide a financial cushion during the M&A process.

These steps not only improve liquidity but also lay the groundwork for incorporating technology to monitor and manage working capital more effectively.

Using Technology for Real-Time Data

Technology plays a pivotal role in managing working capital during M&A. Real-time data tracking enables companies to monitor their financial health continuously and make quick, informed decisions. Modern tools go far beyond traditional spreadsheets, offering deeper insights into complex financial data.

Treasury management systems (TMS) are particularly useful, providing real-time visibility into cash positions across all entities involved in the deal. This facilitates faster decision-making and helps maintain liquidity. Michelle Golembieski, Executive Director of Corporate Treasury Consulting at J.P. Morgan, highlights the importance of technology in this process:

"We see companies building complex technology ecosystems to gain working capital efficiencies because their existing systems can't accomplish what they need. In building that technology stack, companies must balance making existing technology work through bolt-on technology modules and replacing their outdated systems with the newest technology."

Research shows that 74% of CEOs view technology integration during M&A as a key driver of growth and a competitive edge. Upgrading to cloud-based platforms that connect systems across departments can eliminate data silos, automate repetitive tasks, and reduce the integration challenges that often derail M&A deals.

When combined with coordinated team efforts, these technological advancements can significantly enhance working capital management.

Getting Teams to Work Together

Collaboration across departments is essential for managing working capital effectively during M&A. Finance, operations, and sales teams must align their efforts to safeguard cash flow and maintain operational stability. Establishing a governance structure early on can help identify synergies, streamline operations, and uncover cost-saving opportunities that directly impact working capital.

Involving team members from the target company early in the process is equally important. Integration leaders should use due diligence findings to understand working capital needs, while IT teams ensure that systems and data are aligned. Retaining key personnel ensures continuity and preserves valuable institutional knowledge.

A centralized Integration Management Office (IMO) can help coordinate these efforts, ensuring that working capital improvements align with the overall deal strategy.

For companies navigating the complexities of M&A, expert advisory support - like that offered by Phoenix Strategy Group - can be instrumental in aligning financial and operational systems, preserving liquidity, and optimizing working capital. These efforts are critical to achieving the benchmarks set during the transaction phase.

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Managing Working Capital After M&A Completion

After a merger or acquisition, keeping a close eye on working capital is essential to hitting financial targets. The success of the merged entity often depends on careful planning and ongoing monitoring to ensure everything stays on track. As discussed earlier, setting clear working capital benchmarks is critical, but reaching those goals post-deal requires a solid integration plan and constant attention.

Creating a Post-M&A Integration Plan

The first 100 days after the deal closes are crucial. A well-structured integration plan during this period lays the groundwork for stabilizing working capital and achieving the financial goals set during negotiations.

One of the first tasks is aligning financial systems. Within 30 to 120 days post-closing, buyers typically receive a net working capital statement, which is used to finalize purchase price adjustments. This "true-up" process ensures the final price reflects the actual net working capital at closing, reducing the risk of financial surprises and aligning both parties' interests.

Standardizing accounting policies and the chart of accounts is another essential step. This helps uncover any inconsistencies and ensures financial reporting is clear and accurate.

Systems integration also plays a big role. Finance and accounting teams often need to merge systems, either by upgrading an existing platform or adopting a new one. The goal is to create financial reports that reflect the merged company's structure without disrupting operations.

For example, QX Global Group saved over $5 million annually by implementing a plug-and-play model through a Global Business Services center. This standardized system helped them maintain consistent working capital management across all entities.

Inventory management is another area that needs immediate attention. During the first 100 days, the integration team should assess inventory levels, identify redundancies, and create unified procurement processes. Digital tools like automated purchase order systems can make this process more efficient and reduce errors.

Similarly, aligning accounts receivable (AR) and accounts payable (AP) processes is critical for maintaining cash flow. In one instance, a company reviewed receivables on a customer-by-customer basis, comparing payment terms with actual records. This allowed them to renegotiate terms, update IT systems, and eliminate unnecessary early-payment discounts.

Ongoing Monitoring and Improvements

Once the initial integration stabilizes working capital, the focus shifts to long-term monitoring and improvement. Sustaining financial efficiency requires regular reviews and adjustments. Companies should establish tracking systems that include quarterly reviews of key performance indicators (KPIs) like payables turnover, receivables turnover, current ratio, quick ratio, and cash conversion cycle.

A baseline analysis of net working capital across regions, business units, and segments can pinpoint areas where cash is being burned or generated. This helps set realistic goals based on internal and external benchmarks.

Digital tools can also make a big difference. Dashboards, advanced analytics, and machine learning provide real-time insights, while stress testing under different economic scenarios ensures liquidity and highlights potential risks. Automated reporting systems that track cash conversion cycles, payment term compliance, and inventory turnover rates - combined with electronic invoicing - can further enhance cash flow management.

Collaboration across departments is key to long-term success. Teams from sales, finance, and supply chain need to work together to keep order-to-cash processes running smoothly. Regular communication helps quickly identify and address changes in customer payment patterns or supplier terms.

As PwC research highlights:

"9 / 10 transactions succeed if the integration/carve-out of the Finance function is performed well."

This statistic emphasizes how critical a well-managed approach to working capital is during the post-merger phase.

For companies facing these challenges, expert guidance can be a game-changer. Consider the financial and strategic advisory services offered by Phoenix Strategy Group, which specialize in helping growth-stage companies navigate post-merger complexities and achieve financial stability.

Conclusion: Building Financial Stability Through Working Capital Management

Looking back at the insights into M&A and working capital management, it’s clear that effective management isn’t just about hitting short-term goals - it’s about laying the groundwork for lasting success. Companies that excel post-merger treat working capital management as an ongoing strategic focus rather than a one-off task.

The role of data in this process cannot be overstated. With nearly 40,000 M&A deals completed globally in 2023 and 60% of executives believing better data could improve outcomes, the importance of informed decision-making is undeniable. As Michelle Golembieski, Executive Director of Corporate Treasury Consulting at J.P. Morgan, puts it:

"Implementing working capital optimization strategies can help midsize businesses improve their overall financial performance."

Collaboration across departments is another key to success. General Electric’s approach to cash flow forecasting - bringing together representatives from different business units and regions - enhanced accuracy and highlighted the power of teamwork.

Meanwhile, advanced analytics and integrated platforms are helping businesses achieve real results. For example, a diversified game publisher used modern, data-driven technologies to realize over 25% of its merger synergies, shifting its working capital management approach from reactive to proactive.

Sustained success also relies on regular monitoring. Quarterly reviews of metrics like payables turnover, receivables turnover, and cash conversion cycles keep businesses on track. The guiding strategy is straightforward: reduce inventory and receivables while increasing payables, all supported by precise tracking and coordinated team efforts.

For growth-stage companies navigating these challenges, Phoenix Strategy Group offers financial and strategic advisory services to streamline working capital management throughout the M&A process, from initial due diligence to post-merger integration.

FAQs

How do working capital benchmarks in specific industries impact M&A deals?

Industry-specific working capital benchmarks are key in mergers and acquisitions, providing a clear framework for assessing a target company's financial health. These benchmarks establish the expected working capital levels that must be delivered at closing, which can directly influence the purchase price. For instance, if the actual working capital falls short or exceeds the agreed-upon target, adjustments to the purchase price may follow.

By analyzing these benchmarks, buyers gain insight into the target company's operational liquidity and cash flow requirements. This helps ensure the business can maintain its operations after the acquisition without needing immediate additional funding. Agreeing on these financial metrics not only simplifies negotiations but also lays the groundwork for a smoother transition and a more seamless integration once the deal is completed.

How can companies improve working capital management after a merger?

Improving working capital management after a merger begins with a thorough evaluation of the merged company’s financial standing. This involves analyzing inventory levels, accounts receivable, and accounts payable to uncover inefficiencies and pinpoint potential areas where the two entities can work more effectively together. Setting a clear baseline is crucial for defining measurable goals and tracking progress post-merger.

A well-structured integration plan is equally important. Aligning financial systems, policies, and processes across the merged organizations ensures smoother cash flow management and minimizes disruptions. Strong communication between finance teams plays a key role here, enabling faster decision-making and helping to address any challenges as they arise.

Additionally, companies should establish and track key performance indicators (KPIs) specific to working capital. Regular monitoring of these KPIs allows for timely adjustments to strategies, ensuring cash flow optimization and financial stability throughout the integration process.

How does technology improve financial tracking and decision-making during M&A transactions?

Technology has become a game-changer in how financial tracking and decision-making are handled during mergers and acquisitions (M&A). By automating complex data analysis and simplifying workflows, it delivers quicker, more precise insights. For instance, AI-powered platforms and advanced analytics tools can sift through massive amounts of financial data in real-time. This helps businesses spot trends, identify potential risks, and even forecast possible outcomes for a deal.

These tools also enhance teamwork by giving all stakeholders access to the latest information, which makes negotiations and integration planning run more smoothly. By integrating technology into the M&A process, companies can make smarter, data-backed decisions, minimize risks, and drive better outcomes.