My Car Has Working Capital

My Car Has Working Capital

By Dan Vermeire

January 20, 2015

CarMost transactions deal with the subject of Working Capital. But what is Working Capital?  And how does it affect the purchase price?  A very familiar and simple example is when buying a used car.  Yes, a car does have Working Capital.

Let’s say your neighbor is selling a used car.  You look it over, want to buy it, and agree on a price. You notice that the car has a half-tank of gas.  It also has about $20 of change in the cup holders.  And it still has $2K on the bank note.  So, the deal is, you’ll buy the car for X price, and agree that it will have a half-tank of gas.  Less gas and he owes you some cash.  Also, the seller can keep the $20 change, but he must pay off the bank note.

For a business, Working Capital is usually AR + Inventory, minus AP.  Notice that Cash is not in the equation, because cash is really a by-product of Working Capital.  If Working Capital goes down, by collecting more AR, then cash goes up.  If Working Capital goes up, by paying off AP, then cash goes down.  In a transaction, Working Capital is analyzed and an “appropriate” level is agreed.  After the deal closes, if Working Capital was too low, then some cash is used to make up the difference.  So, the Working Capital is like the half-tank of gas when you buy a car.

An additional concept is “cash-free, debt-free” and most business transactions are done on this basis.  The seller is responsible for any debt, other than trade AP, which is like paying off the bank note on the used car.  Also, usually the seller keeps the excess cash, after Working Capital is satisfied, similar to the change in the cupholders.

There are many more details about Working Capital, so please call CFA to learn how the used car can apply to your transaction!

Posted by Dan Vermeire.

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