Why growth can absorb cash
A company can record higher profit while waiting longer for customers to pay or holding more stock. That cash cannot automatically be treated as surplus. Examine the timing of collections, supplier payments and operating requirements alongside the profit and loss account. Seasonal peaks may be more revealing than a single balance-sheet date.
A simple operating working capital illustration
| Illustrative operating balances | Period A | Period B |
|---|---|---|
| Trade debtors | £180,000 | £240,000 |
| Stock | £70,000 | £90,000 |
| Less trade creditors | − £100,000 | − £120,000 |
| Simplified operating working capital | £150,000 | £210,000 |
On these deliberately simplified definitions, the business has £60,000 more tied up in operating working capital in Period B. This is not a transaction adjustment or a complete cash flow statement. Actual definitions can include other items and must be agreed for the relevant purpose.
Avoid counting the same balance twice
A valuation bridge needs consistent treatment of cash, financing balances and operating items. An item should not be included in a working capital adjustment and also deducted as debt without justification. Shareholder loans, accrued items and leases require clear classification under the agreed valuation or transaction definitions.
Explain seasonality before setting a reference point
Prepare monthly balance sheets where available and explain the operating cycle. A year-end balance after a busy collection month may not represent the normal funding requirement. Identify overdue debtors, obsolete stock, unusually delayed supplier payments and exceptional movements. A mechanical average needs context rather than automatic acceptance.
Questions to ask before comparing offers
Ask what working capital is expected at completion, which items are included, which accounting policies apply and how differences are settled. Legal and accounting advisers should review the proposed mechanism. The valuation brief should distinguish an illustrative equity bridge from a binding purchase-price calculation.
Read the pre-sale price bridge and clarify the valuation date and information cut-off.