Buying a business in California has many complexities. How to determine working capital needs? Understanding the business value, negotiating with the seller, obtaining finance, conducting due diligence, working with attorneys, accountants, tax advisors, government agencies, and more.
With so many areas to review, negotiate, and decide on, there is one area that is often easy to overlook. This is the amount the buyer needs to manage working capital to operate the business.
The reason a buyer can forget is that the seller generally will not think about it. The seller’s concerns are selling their business and their plans. They have little concern about the future success of the business in California, as this decision is ultimately the buyer’s.
What is Working Capital
Working Capital, at its simplest, is the amount of money a business needs to operate on a day-to-day basis to cover its costs, ensuring it remains operational and can build long-term surplus profit.
How to Determine Working Capital Needs
There is no one-size-fits-all amount of working capital the buyer needs. A better question would be: “How much does the buyer need when they take over the ownership and operation of the business?”
The reason this is a better question is that the buyer needs to consider the following to arrive at the right amount of working capital they need to own and operate their business.
- How is the business currently performing? Is it growing quickly, declining quickly, or nice and steady? Working capital needs are more unpredictable for businesses that are either fast-growing or fast-declining. A steady business has a more predictable amount of working capital.
- Does the business make one-off, unpredictable, large expenditures?
- Is the business seasonal, meaning does its performance change significantly throughout the year? If so, does the amount of working capital fluctuate with the demands of the season?
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How Does the Buyer Determine the Right Amount
It is far better for the buyer to have too much than not enough.
Insufficient working capital can lead to the closure of the business. Not enough is also not good, as it means money is not being appropriately deployed, resulting in a reasonable rate of return.
To determine the right amount of working capital, consider the following.
- Ask the seller for their recommendation. If the seller provides a recommendation, ask them to explain the number so you can verify its accuracy.
- Ask your accountant or CPA to help make that calculation.
- Other sources of information include checking with the trade association of the industry in which the business operates. As for them, if they can suggest what is normal for the industry. Ratios may be available, such as working capital as a percentage of sales.
- The amount of working capital should be calculated from the financial statements; ensure that the financial statements are accurate.
Working Capital for your Business in your Industry
It is easy to forget or miscalculate the amount of working capital, especially when buying a business and having numerous other items to address.
It’s crucial to research and understand the working capital requirements for your specific business within your industry.
This means making calculations not only for the first few months after you take over ownership of the business, but also for the whole year. For example, some retail businesses generate the majority of their annual sales in the 10 weeks leading up to Christmas.
If the buyer takes over in February and cruises to August, thinking the business is in good shape, they may need to buy a lot of inventory for Christmas items but lack the necessary amount of capital.
The capital has no room for error when buying a business. Get it right and the business has a chance at success. Also, remember that the need for working capital is never static and constantly changes.
If you would like more information about finding a business opportunity, please visit our business listings here: Buy a Business for Sale.
For more immediate assistance with purchasing a business for sale, you are welcome to contact Andrew Rogerson, a certified business broker based in Sacramento, California, who services the entire state. Call Toll-Free at (844) 414-9700 or email him at support@rogersonbusinessservices.com.
Further reading
Sell a California Small Business: How Much Tax I Need to Pay?
Selling A Business To A Strategic Buyer | 10 Factors in California
Accurate Financial Statements When Selling a California Businesss
The Uncertainty Principle when Selling or Buying a California Business