Working capital is where many transaction disputes start. A seller can collect receivables aggressively, run down stock and delay supplier payments in the months before closing, handing over a business that needs an immediate cash injection to operate normally. Equally, a buyer can argue for an unrealistically high working capital target to reduce the price. Financial due diligence addresses both risks by testing each component and setting a normal, or "normalised", level of working capital.
This article explains the practical checks performed on receivables, inventory and payables, how monthly trends are used to set the net working capital (NWC) peg, and how the peg works in completion accounts and locked box deals. It is written for buyers, sellers and finance teams involved in share or business acquisitions.
Key points at a glance
- Working capital is reviewed through ageing, subsequent collections and payments, and monthly trends, not only through ratios.
- The definition of NWC in the agreement (what is included and excluded) matters as much as the numbers.
- The peg is usually based on an average of 12 monthly balances to remove seasonality and period-end effects.
- In completion accounts deals, the price is adjusted rupee for rupee for the difference between actual and pegged NWC.
- Overdue MSME payables carry interest and tax consequences and are often treated as debt-like rather than working capital.
What is net working capital in a transaction?
For deal purposes, net working capital generally means trade receivables, inventory, and other operating current assets, less trade payables and other operating current liabilities. Cash, borrowings, income tax balances and non-operating items are usually excluded, because they are dealt with through net debt. The exact definition is negotiated and written into the share purchase agreement, and consistency between the due diligence analysis and that definition is essential.
Receivables: what is tested
Ageing and overdue analysis
Customer-wise ageing is analysed into buckets (0-30, 31-60, 61-90, 91-180, over 180 days) and compared against agreed credit terms. The review distinguishes between amounts that are old but collectible and those that are effectively bad debts not yet provided for.
Subsequent collections
Collections after the balance sheet date are traced to bank statements. Balances not collected within a reasonable period, and not supported by correspondence or confirmations, are candidates for provision.
Concentration and terms
The share of the top customers in receivables, extensions of credit periods and changes in terms around year-end are reviewed. A rise in debtor days concentrated in one or two customers is a different risk from a general slowdown in collections.
Credit notes and disputes
Credit notes issued after year-end, disputed invoices and unreconciled differences with customer ledgers indicate that some receivables may not represent valid sales.
Inventory: what is tested
- Ageing and movement: items with no movement for six or twelve months, and stock of discontinued products.
- Valuation: the cost formula used, overhead absorption, and whether net realisable value is below cost for slow-moving items.
- Build-ups: stock growth faster than sales, especially at year-end.
- Physical verification: the results of the last count, differences written off, and stock held with third parties or job workers.
Payables: what is tested
- Payments against agreed credit terms, and any stretching of payments at the period-end.
- Dependence on a few suppliers and the risk that credit terms tighten after a change in ownership.
- Payables to MSME suppliers beyond the time limit in Section 15 of the MSMED Act, 2006 (45 days where agreed in writing, otherwise 15 days). Such amounts attract compound interest under that Act and are allowed as a tax deduction only on payment under Section 43B(h) of the Income-tax Act, 1961 (Section 37 of the Income-tax Act, 2025).
- Unrecorded liabilities: invoices received after year-end relating to earlier periods.
How the NWC peg is set: a worked example
Consider a seasonal consumer products company with monthly NWC (receivables plus inventory less payables) over the last 12 months as follows:
| Month | NWC (₹ crore) | Month | NWC (₹ crore) |
|---|---|---|---|
| April | 16.0 | October | 22.0 |
| May | 17.0 | November | 20.0 |
| June | 18.0 | December | 18.0 |
| July | 19.0 | January | 17.0 |
| August | 21.0 | February | 16.0 |
| September | 23.0 | March | 13.0 |
The 12-month total is ₹220 crore, giving an average of about ₹18.3 crore. The March figure of ₹13 crore is well below the average, which on review is explained by year-end collection drives and delayed supplier payments.
Due diligence then normalises the average for items that should not be in it:
- Receivables over 365 days of ₹0.8 crore that are not collectible: removed, reducing NWC to ₹17.5 crore.
- Obsolete inventory of ₹0.5 crore: removed, reducing NWC to ₹17.0 crore.
- Overdue MSME payables averaging ₹1.0 crore reclassified as debt-like: removed from payables, which increases NWC to ₹18.0 crore, with the same amount deducted in net debt.
The peg is set at ₹18 crore. If the deal closes in October, when NWC is expected to be ₹22 crore, the buyer pays ₹4 crore more; if it closes in March at ₹13 crore, the buyer pays ₹5 crore less. The adjustment protects both sides from timing and from pre-closing management of working capital.
Practical point: Where the business is growing, a trailing 12-month average may understate the working capital required at closing. Parties sometimes use the average of the most recent months or scale the peg to revenue. The chosen method should be explicit in the agreement.
Completion accounts versus locked box
| Aspect | Completion accounts | Locked box |
|---|---|---|
| Reference date for price | Closing date | A past balance sheet date agreed before signing |
| Working capital adjustment | Actual NWC at closing compared with the peg; price adjusted after closing | No post-closing adjustment; NWC at the locked box date is priced in |
| Protection against value leakage | Through the adjustment mechanism | Through covenants against "leakage" such as dividends and non-arm's length payments |
| Role of due diligence | Defines NWC, sets the peg, supports closing accounts | Tests the locked box balance sheet thoroughly before signing |
Common mistakes in working capital analysis
- Setting the peg on the year-end balance alone, which is often the lowest point of the year.
- Using a definition in the agreement that differs from the one used in the analysis.
- Leaving advances from customers, GST input credit and statutory dues unclassified.
- Ignoring the effect of normalised supplier terms after the change in ownership.
- Counting a provision both in EBITDA adjustments and again in the peg.
Frequently Asked Questions on Working Capital Due Diligence
What is a working capital peg?
It is the normal level of net working capital agreed between buyer and seller, usually based on a 12-month average, against which the actual working capital at closing is compared to adjust the price.
Why is a 12-month average used for the peg?
Because monthly averages remove seasonal swings and period-end management of receivables, inventory and payables, giving a more representative level.
What is included in net working capital for a deal?
Usually trade receivables, inventory and other operating current assets less trade payables and other operating current liabilities, excluding cash, debt and tax balances. The final definition is agreed in the transaction documents.
How are overdue MSME payables treated in due diligence?
Payables beyond the MSMED Act time limit carry interest and are deductible for tax only on payment, so they are often treated as debt-like items rather than normal working capital.
What is the difference between completion accounts and locked box?
In completion accounts, the price is adjusted after closing for actual net debt and working capital; in a locked box, the price is fixed on an earlier balance sheet and the buyer is protected by leakage covenants.
How is inventory tested in due diligence?
Through ageing and movement analysis, review of valuation and net realisable value, comparison of stock growth with sales and review of physical verification results.
Conclusion
Working capital review turns the balance sheet into a picture of how the business actually operates: how quickly customers pay, how much stock is needed and how suppliers are treated. The peg brings that picture into the price, so that neither party gains from the timing of closing.
A clear NWC definition, a peg based on monthly data and consistent treatment of debt-like items reduce the scope for disputes when closing accounts are prepared.
This article is intended for general information and knowledge sharing only and does not constitute professional advice or solicitation of any kind. Provisions are summarised as of September 2026. Readers should refer to the relevant provisions, regulations and judicial pronouncements for their specific facts.