When you’re buying a business, it’s easy to get caught up in headline numbers: the purchase price, revenue projections, profit margins. But one critical element often gets overlooked — working capital. Ignore it, and you could end up owning a business that’s technically yours but practically crippled from day one.
What Is Working Capital?
Working capital is the money a business needs to run its day-to-day operations. It’s the difference between current assets (cash, accounts receivable, inventory) and current liabilities (accounts payable, short-term debt). Positive working capital means a company can pay its bills and reinvest in growth. Negative working capital means it’s scrambling just to stay afloat.
Why Working Capital Matters When Buying a Business
When you buy a business, you don’t just need enough money to pay the seller. You need enough to operate the business starting Day One. Customers still need to be served, suppliers still need to be paid, employees still expect paychecks.
Without enough working capital:
- You can’t buy inventory.
- You can’t cover payroll.
- You can’t pay suppliers.
- You might even have to take on expensive emergency financing.
The result? A profitable business on paper could collapse in practice. Worse, many deals are structured “cash-free, debt-free” — meaning you might inherit a business stripped of cash reserves. If you didn’t factor working capital into your budget, you’re instantly in the hole.
How Much Working Capital Do You Need?
There’s no single answer, but here’s a practical approach:
- Analyze the Business’s Historical Working Capital
- Look at the last 12-24 months.
- How much working capital did it typically need to function smoothly?
- Pay attention to seasonal swings. A retailer in December has very different needs than in June.
- Negotiate a “Normalized” Working Capital Target
- As part of the purchase agreement, set a working capital target.
- If the actual working capital at closing is below the target, the purchase price gets adjusted.
- Plan for a Buffer
- Beyond normal operations, you need a cushion for unexpected issues (a slow-paying customer, supplier price hikes, etc.).
- A good rule of thumb: 1 to 2 months’ worth of operating expenses as a buffer.
- Understand the Industry Norms
- Service businesses often need less working capital.
- Inventory-heavy businesses (retail, manufacturing) usually need more.
Quick Formula
Working Capital Needed = (Average Monthly Operating Costs x 2) + Expected Inventory Purchases + Any Startup Costs
Adjust based on specific risks or seasonal trends.
Final Thought
Working capital isn’t an afterthought. It’s the lifeblood of the business you’re buying. Plan for it as seriously as you plan the purchase price, or risk owning a business that’s yours in name but broken in reality.
Bottom line: When buying a business, work out how much working capital you need, negotiate it into the deal, and make sure you have it ready. Otherwise, you’re not buying a business; you’re buying a problem.
