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Definition of Net Working Capital

Net working capital (NWC) is a financial metric that represents the difference between a company's current assets and its current liabilities. It reflects the firm's ability to meet its short-term financial obligations and operational needs. 

Where startups may encounter net working capital is in a sale of the company. In an acquisition, net working capital plays a crucial role in determining the purchase price and assessing the financial health of the target company. Let's look at an example.

Let's say Company A is acquiring Startup B. During the due diligence process, Company A analyzes Startup B's financial statements and calculates its NWC. If Startup B has a positive NWC, it indicates that the company has enough current assets to cover its short-term obligations, and it may suggest financial stability. Conversely, if Startup B has a negative NWC, it might signal liquidity issues or mismanagement of working capital.

Company A might negotiate the purchase price based on the calculated NWC. If the agreed-upon price is subject to a "working capital adjustment," it means that Company A and Startup B will reconcile the actual NWC at the time of closing against an agreed-upon target NWC. If the actual NWC is higher than the target, Company A may pay less, and if it's lower, Company A may pay more.