Glossary
Net Working Capital Peg: How It Is Set, With a Worked Example
A net working capital peg is the agreed level of operating working capital a business must be delivered with at closing, usually set from a trailing monthly average. The closing figure is measured against it under the agreement’s price-adjustment formula.
The peg can materially change equity proceeds. Agree its definitions before signing; the agreement may provide an estimated adjustment at closing and a later true-up, as well as caps, collars or thresholds. For how the underlying figure is built, see net working capital. This page covers the deal mechanic and how the target is set.
What is a working capital peg in simple terms?
A buyer pays for a business that can run on day one. That needs a normal level of receivables, inventory and prepaid costs, less normal payables and accruals. The peg is that normal level, written into the purchase agreement as a number.
After closing, actual working capital is measured on the closing balance sheet:
Above the peg:
the seller delivered more than promised, and the buyer pays the difference.
Below the peg:
the seller delivered less, and the price comes down by the difference.
A buyer who accepts a peg set too low funds the shortfall in the first months of ownership, before collections have funded the transition. A seller who accepts one set too high gives back part of the price.
How is the working capital peg calculated?
The agreement defines it, so there is no single formula. A reproducible analysis follows these steps:
- Pull month-end balance sheets for at least twelve months, preferably twenty-four.
- Keep operating accounts only: receivables, inventory, prepaids, payables, accrued liabilities, and work in progress where relevant.
- Remove cash and debt. For a cash-free, debt-free deal, separate qualifying cash and financing. Specify the treatment of leases, taxes and related-party balances rather than assuming every such account is excluded. See net debt calculation.
- Normalize balances that are wrong or one-off: stale receivables, inventory estimates and suspense/adjustment accounts that lack adequate support, under-accrued liabilities.
- Choose the averaging window and calculate the arithmetic mean of the month-end balances in it.
- Write the method down alongside the number.
Our transaction team starts from a trailing twelve-month average and moves away from it only for a reason: growth or decline, strong seasonality, or months that cannot be relied on, such as those around a change of accounting system.
How much can the window change the peg? A worked example
The figures below are invented for illustration: a seasonal business with working capital that peaks in summer. Amounts are CAD thousands, after removing cash, debt-like items and non-operating balances.
| Month | Reported | Adjusted | vs 12-month average |
|---|---|---|---|
| Oct 2025 | 393 | 330 | -13.75 |
| Nov 2025 | 334 | 285 | -58.75 |
| Dec 2025 | 293 | 253 | -90.75 |
| Jan 2026 | 271 | 242 | -101.75 |
| Feb 2026 | 298 | 258 | -85.75 |
| Mar 2026 | 356 | 295 | -48.75 |
| Apr 2026 | 420 | 345 | +1.25 |
| May 2026 | 496 | 395 | +51.25 |
| Jun 2026 | 529 | 432 | +88.25 |
| Jul 2026 | 544 | 448 | +104.25 |
| Aug 2026 | 534 | 437 | +93.25 |
| Sep 2026 | 493 | 405 | +61.25 |
| 12-month average | 413.42 | 343.75 | |
| 12-month median | 337.50 | ||
| 6-month average (Apr to Sep) | 410.33 | ||
| 3-month average (Jul to Sep) | 430.00 |
Three things fall out of this table:
The adjustments matter before the method does.
Removing cash, adding back debt-like liabilities and removing net non-operating items moves the twelve-month average from 413.42 to 343.75.
The window is worth real money.
A twelve-month peg of 343.75 and a six-month peg of 410.33 are 66.58 apart on identical books. Across all the windows shown, the spread is 86.25.
The closing month matters as much as the peg.
Against a twelve-month peg, a closing balance at the January level produces a shortfall of 101.75. At the July level it produces a surplus of 104.25.
You can reproduce this, or run your own figures, in our net working capital peg calculator. It runs in the browser, compares every window side by side and shows each month against the average. It gives arithmetic, not a recommended peg.
Should the peg use a 12-month, 6-month or 3-month average?
| Situation | Comparison to test | Why |
|---|---|---|
| Stable revenue and costs year over year | Trailing 12 months | Captures one full seasonal cycle |
| Business growing quickly | Recent 6 or 3 months, checked against the same season last year | A twelve-month average can lag growth; a shorter window can also overstate a seasonal peak |
| Strong seasonality | Trailing 12 months, sometimes adjusted for seasonality | A short window can capture only the peak or only the trough |
| Accounting system changed in the period | Reconciled months before and after the change | Prove whether migration affected comparability before discarding a period |
| Business shrinking | Recent months plus receivable and inventory analysis | Sales can fall before old receivables or inventory unwind |
The growth case cuts both ways. In our engagements, when a seller argues that recent months show the business’s new earnings level, our position has been that the same recent months should set the working capital target too. Ask whether the operating balances needed to support the earnings case have changed. Different windows can be justified, but the assumptions should reconcile.
Does the peg include cash or debt?
No, in a cash-free, debt-free deal. Cash goes to the seller or settles debt at closing, and debt is deducted from the price separately. The common error is a peg calculated as current assets minus current liabilities straight from the balance sheet. That figure includes the current portion of loans, which lowers working capital for reasons that have nothing to do with operations. In our transaction work we have seen that leave a seller’s own figure well below the normalized one.
What must both sides agree besides the number?
In a retrospective discussion, our transaction lead described a pre-closing disagreement that exposed two meanings of the same number. One side understood the figure as the amount the business needed to operate; the other understood it as the amount the seller had committed to deliver. Agreement on the arithmetic had not established agreement on the obligation.
That is why the schedule should answer each of these questions:
| Question | What the written schedule should settle |
|---|---|
| What is being delivered? | Included and excluded accounts, mapped to the ledger |
| How is each account measured? | Inventory valuation, receivable allowances, accruals and cut-off policies |
| How was the target derived? | Months, corrections, averaging method and seasonality rationale |
| How is closing NWC measured? | Same definitions and policies, with worked calculations |
| Who can inspect the support? | Preparer, records available, deadlines and objection process |
| How does a difference change price? | Sign convention, caps/collars if any, payment timing and dispute mechanism |
Inventory deserves particular attention. If the historical balances behind the peg used one policy and the closing count uses another, a difference may reflect measurement rather than what the seller delivered. See inventory in due diligence.
How are deposits and deferred revenue treated?
Agree the treatment across the full price bridge, not just the peg. Customer advances can leave the buyer with work, refund exposure or both after the seller has received the cash.
| Possible treatment | What to test |
|---|---|
| Include the liability in operating NWC | Apply the same treatment in the historical peg and closing calculation; understand normal advance collections |
| Treat an agreed amount as debt-like | Remove overlapping NWC treatment and specify how the amount is measured |
| Negotiate retained cash or a separate adjustment | Identify the remaining performance/refund obligation and reconcile it with any other price deduction |
Full face value and estimated cost to fulfil are different measurements. Neither is automatically correct for every business. Prepare the contract schedule first, then have the parties and counsel agree the economic treatment. Our transaction advisory team can model the alternatives so their effects on proceeds and day-one cash are visible.
Do small deals need a peg?
Not always. On very small transactions the machinery can cost more than it protects, and going without is a legitimate choice. Make it deliberately: without this adjustment mechanism, the parties still need to specify which assets and liabilities transfer and how the buyer funds operations. Other structures may address that need.
Frequently asked questions
Who sets the working capital peg?
It is negotiated, usually from an analysis each side’s advisers prepare. On the buy side we propose a target from tested figures as part of quality of earnings work, not from the seller’s presentation.
What is the difference between the peg and the true-up?
The peg is the agreed target. The true-up is the comparison of actual closing working capital with that target, and the price adjustment that follows.
When is the true-up settled?
The closing figure is usually prepared shortly after closing, with the adjustment settled within the period the agreement specifies.
Can the adjustment be capped?
Yes. Collars, thresholds and caps are negotiable. Whether they help you depends on which side of the likely variance you sit, which the month-by-month view above makes visible.
Is the average or the median used?
Our team uses an average as a starting comparison. The median is a useful check: a gap between them warrants checking the distribution, growth trend and unusual months.
Where to next
Run your own figures through the peg calculator to see how much the window and the closing month move the answer. For common errors around the number, read working capital mistakes in acquisitions. Sellers can check what diligence is likely to find with the QoE readiness check. To set a peg from tested balances on a live deal, talk to our transaction advisory services team, or email Avnit Sekhon, CPA at avnit.sekhon@treewalk.com.
