Meaning
The accounting recognition of unpaid liabilities or uncollected revenues at the date of closing to determine the final working capital. Calculating the working capital accrual correctly is necessary to adjust the purchase price of the business at closing. This adjustment ensures that the buyer is not left with unpaid pre-closing liabilities or uncollected revenues without a corresponding price adjustment.
Accrual Methodology
Accountants identify all expenses incurred before the closing date that have not yet been invoiced. These items, such as employee bonuses or utility bills, are recognized as liabilities on the closing balance sheet. This recognition reduces the final working capital of the business.
Capital Adjustment
The purchase agreement defines a target working capital that the business must have at closing. If the calculated accruals reduce the actual working capital below this target, the seller must refund the difference to the buyer. If the working capital is higher than the target, the buyer pays the seller.
Audit Verification
The buyer’s accountants audit these accruals after closing to ensure they are accurate and complete. If disputes arise, they are resolved through the true-up process defined in the purchase agreement. This audit protects both parties from balance sheet manipulation.
