Much of the
training Redcliffe delivers on M&A transactions is not designed to turn lawyers, bankers or advisers into accountants. In fact, even qualified accountants often find these concepts challenging; M&A definitions are heavily negotiated constructs that simply do not map onto traditional accounting standards.
Training is designed to ensure that both financial and non-financial professionals are aware of the commercial dimensions of a deal to ask the right questions; it ensures they recognise when the answers they are getting may not be the right ones.
Nowhere is that more important than in understanding how cash, debt and working capital in M&A are defined and treated in an acquisition agreement.
The Starting Point Looks Familiar; It Does Not Stay That Way
In a standalone corporate finance context, the definitions are relatively straightforward.
Cash is cash. Debt is what appears on the balance sheet as a financial liability. Working capital is current assets minus current liabilities, calculated in accordance with the applicable accounting standards.
In M&A, none of those definitions can be taken for granted. Each is a negotiated concept, and the negotiated outcome can differ significantly from the accounting starting point. Understanding why (and what is at stake) is one of the most practically valuable insights an adviser or financial controller can take into a transaction.
And the stakes are not theoretical.
Working capital purchase price adjustments now feature in more than 90% of private-target deals, up from around half a decade ago, according to
SRS Acquiom's 2026 study of over 1,500 transactions. The mechanism has gone from an occasional refinement to a near-universal feature of the modern SPA. If you advise on deals and you are not fluent in it, you are exposed.
Cash
In a standalone valuation, cash is typically treated as a single line item that increases equity value pound for pound. In an acquisition agreement, that treatment depends entirely on what kind of cash it is.
Not all cash on a target's balance sheet is freely available to a buyer.
Some is operationally necessary and must remain in the business as a minimum cash. Some is legally or structurally inaccessible, whether because of:
- Regulatory requirements
- Foreign exchange controls
- Contractual restrictions
- Or the absence of distributable reserves in a subsidiary
The M&A treatment of each category is different; confusing them can lead to material value leakage for sellers or overpayment by buyers.
The definition of "Cash"
in an SPA is therefore heavily negotiated. What is included, what is excluded and how to treat trapped or restricted cash are all live issues in most transactions. Because navigating these differences is so critical to the equity bridge, we will explore the precise mechanics of surplus, operational, and trapped cash in a follow-up article.
Debt
In a standard balance sheet analysis, debt means recognised financial liabilities: bank borrowings, bonds, finance leases and similar items. In M&A, the concept of debt (or more precisely, debt-like items) is significantly broader.
Acquisition agreements routinely treat items as debt-like deductions from equity value that would never appear as debt in the financial statements. These include pension deficits, earn-out obligations, warranty or indemnity exposures, tax liabilities arising from the transaction, and certain provisions or contingent liabilities. The scope of what counts as a debt-like item is one of the most heavily negotiated aspects of any deal, and the financial consequences of getting it wrong can be substantial.
Why does this matter so much?
Because every pound reclassified from working capital into debt is a pound deducted from the seller's proceeds. A liability that looks innocuous on the face of the accounts (an underspent maintenance capex backlog, say, or a deferred bonus pot) can become a contentious debt-like item worth several percentage points of the price.
The label is not cosmetic. It is money.
Working Capital
The accounting definition of working capital is the starting point for the M&A analysis:
Current Assets - Current LiabilitiesBut it is rarely the finishing point. In an acquisition agreement, the definition of working capital is typically adjusted in many important respects.
Cash and debt are excluded from the working capital calculation and dealt with separately via the equity bridge. Exceptional or one-off items are often excluded to give a cleaner picture of normalised trading. The definition is then used to set a target, or "peg" (the level of working capital the seller is expected to deliver at completion), and a true-up mechanism adjusts the price upward or downward depending on whether actual working capital at completion is above or below that peg.
None of that appears in a standard accounting presentation of working capital, and none of it is self-executing. It requires careful drafting, a clear understanding of the business, and close coordination between the financial advisers and the lawyers.
The M&A Working Capital Formula
Strip it back, and the deal definition usually looks like this:
Net Working Capital (M&A) = Current Assets (excluding cash) − Current Liabilities (excluding debt)This is the "cash-free, debt-free" basis on which most private acquisitions are structured. The seller keeps the cash and settles the debt out of the proceeds at completion; the buyer takes on a clean operating business with enough short-term assets to keep running from day one. Cash and debt are stripped out here precisely because they are handled separately in the equity bridge—double-counting them would distort the price.
The principle sounds tidy. The application is anything but.
Because every input is contestable: which receivables are genuinely collectable, how inventory is valued and reserved, whether deferred revenue is a working capital item or a debt-like one, and where the accounting cut-off falls relative to completion. Each of those is a lever, and each lever moves the price.
The Peg and the True-Up: A Worked Example
The peg is the agreed target level of working capital, usually built from a trailing twelve-month average of monthly balances to smooth out seasonality. The true-up then compares actual working capital at completion against that peg and adjusts the price pound for pound.
Here is how it plays out in practice. Suppose the peg is set at £2,000,000.
- If actual working capital at completion comes in at £2,150,000, the seller has delivered £150,000 more than agreed. The buyer pays an additional £150,000.
- If it comes in at £1,850,000, the seller has delivered £150,000 short. The purchase price is reduced by £150,000.
Raising the peg by a pound is functionally identical to cutting the headline price by a pound, which is exactly why the peg is so heavily negotiated. It is, in effect, a zero-sum line item that often receives a fraction of the attention lavished on the EBITDA multiple, despite moving the final number just as decisively.
To stop trivial fluctuations triggering a payment, parties frequently agree on a collar (or tolerance band): a range around the peg within which no adjustment is made. A typical collar might be one to two per cent of the purchase price. Above or below the band, the adjustment kicks in.
Where it Goes Wrong and Why it Matters
Working capital adjustments are among the most common sources of post-completion disputes in private M&A.
The asymmetry is part of the problem: the buyer typically controls the books after completion, prepares the closing statement, and applies its own accounting team's interpretation of the agreement, while the seller reviews it on a tight timetable with limited access to the underlying records. The mechanics usually run to a closing statement delivered within 60 to 90 days, a seller review window of 30 to 60 days, and binding resolution by an independent accountant if the parties cannot agree—a process that itself carries real cost.
The disputes themselves tend to cluster around the same pressure points: receivables collectability and ageing cut-offs, inventory valuation and reserve methodology, accounting cut-off conventions at the completion date, and the perennial question of whether deferred revenue belongs in working capital or sits as a debt-like item.
None of these is resolved by the accounting standards alone. They are resolved by the words in the agreement.
The corporate finance definitions are the starting point; the M&A definitions are where the parties arrive after negotiation. The gap between the two is where value is won or lost. And it is where disputes arise if the definitions are not drafted and understood with sufficient precision.
For advisers and corporate finance teams, the key is to look past standard accounting conventions and understand that these are entirely negotiated constructs.
The SPA definitions control the final financial outcome rather than the financial statements, and the interaction between the cash, debt and working capital definitions needs to be internally consistent. When it is not, even experienced accountants can find themselves caught out when the unintended consequences surface at completion accounts: the worst possible time.
These issues are explored in depth on Redcliffe Training's M&A courses, covering the
financial, accounting and negotiation dimensions of acquisition agreements. If you want to be the person in the room who spots the debt-like item before it becomes a problem, that is where to start.
FAQ
How is working capital calculated in M&A?
In M&A, working capital is typically calculated as current assets excluding cash, minus current liabilities excluding debt. This "cash-free, debt-free" basis differs from the standard accounting definition (current assets minus current liabilities), because cash and debt are dealt with separately through the equity bridge rather than inside the working capital figure.
What is a working capital peg?
The peg is the agreed target level of working capital that the seller is expected to deliver at completion. It is commonly set using a trailing twelve-month average of monthly working capital balances to smooth out seasonal swings. Actual working capital at completion is then compared against the peg, and the purchase price is adjusted up or down for the difference.
What is a working capital true-up?
A true-up is the post-completion adjustment that compares actual working capital delivered at completion with the agreed peg. If actual working capital exceeds the peg, the buyer pays the seller the difference; if it falls short, the purchase price is reduced. A closing statement is usually prepared within 60 to 90 days of completion, with a defined window for the seller to object.
What are debt-like items in M&A?
Debt-like items are liabilities that do not appear as debt in the financial statements but are treated as deductions from equity value in the deal. Common examples include pension deficits, earn-out obligations, warranty or indemnity exposures, transaction-related tax liabilities, and certain provisions. Whether an item is classed as debt-like or left inside working capital is heavily negotiated, because the classification directly affects the seller's proceeds.
Why is cash excluded from working capital in M&A?
Most private acquisitions are structured on a cash-free, debt-free basis, meaning the seller keeps the cash and settles the debt at completion. Cash is therefore excluded from the working capital calculation and credited separately in the equity bridge. Including it would double-count its effect on the price. The exception is restricted or trapped cash, which is treated differently because it is not freely available to the buyer.