A Profitable Business Can Still Run Out of Cash: Why Working Capital Matters in a Sale

A business can be profitable on paper and still struggle to pay its bills.

That may sound contradictory, but profitability and cash flow are not the same thing.

A company can generate strong earnings while having significant amounts of cash tied up in accounts receivable, inventory, or other operating requirements.

For a buyer acquiring that business, understanding those cash requirements can be just as important as understanding the purchase price.

It's one reason I believe working capital deserves attention early in the sale process, not just when the parties are approaching closing.

Profitability Doesn't Tell the Whole Story

When evaluating a business, buyers naturally focus on revenue, EBITDA, and seller's discretionary earnings (SDE).

Those metrics help establish the company's financial performance and support an assessment of its value.

But they don't necessarily tell a buyer how much cash will be needed to operate the business.

Consider a company that generates substantial sales but allows customers 60 days to pay.

The revenue may be recognized, and the company may be profitable, but the cash hasn't necessarily arrived.

Meanwhile, employees need to be paid, inventory must be replenished, and vendors expect payment.

A profitable company can still experience a cash shortage if those obligations come due before enough cash is collected.

What Is Working Capital in a Business Sale?

Working capital generally refers to the resources a business needs to support its day-to-day operations.

In an acquisition, one important measure is net operating working capital, which typically includes operating current assets such as accounts receivable and inventory, less operating current liabilities such as accounts payable.

Cash and interest-bearing debt are generally excluded from this calculation.

But there's another consideration: how much additional cash the buyer may need to maintain operations after closing.

That amount depends on the company's operating cycle, payment terms, seasonality, and other cash requirements.

The distinction matters because the working capital transferred with a business and the cash reserves needed to operate it are not necessarily the same thing.

What Actually Transfers at Closing?

One of the questions I believe buyers and sellers should address early is what is included in the purchase price.

Will accounts receivable transfer to the buyer, or will the seller retain them?

What happens to accounts payable?

Is inventory included in the agreed price, or is it purchased separately?

Will the buyer receive enough operating working capital to continue running the business without an immediate cash shortfall?

These questions can have a meaningful impact on the economics of a transaction.

Two deals with the same headline purchase price can require very different amounts of cash from the buyer depending on what transfers at closing.

The treatment of working capital should be clearly defined in the transaction documents, including any agreed target and closing adjustment.

Seasonality Can Change the Equation

Working capital requirements aren't necessarily constant throughout the year.

A business may need to purchase additional inventory ahead of its busiest season. Payroll and operating expenses may increase before the corresponding customer payments arrive.

The timing of an acquisition can therefore affect how much cash the buyer needs immediately after closing.

A buyer acquiring a seasonal business just before its busiest period may face different cash requirements than one acquiring the same business during a slower period.

That's why historical annual earnings alone may not provide a complete picture.

Understanding the timing of cash coming into and leaving the business is equally important.

Why Sellers Should Care About the Buyer's Working Capital

Working capital isn't just a buyer's concern.

A seller may negotiate an attractive purchase price, but if the buyer doesn't fully understand the cash required to operate the business, problems can emerge during financing, due diligence, or even after closing.

Unclear expectations about receivables, inventory, payables, or the amount of working capital being delivered can also become sources of disagreement late in a transaction.

Addressing these questions early gives both parties a better understanding of what is being purchased and how the business will operate under new ownership.

It also allows the seller to present the business with greater clarity and helps the buyer evaluate the total capital required for the acquisition.

The Purchase Price Is Only Part of the Equation

When someone buys a business, they're not simply purchasing a historical stream of earnings.

They're acquiring an operating company that needs enough resources to continue serving customers, paying employees, and meeting its obligations.

That's why I look beyond the purchase price and earnings when evaluating how a transaction may come together.

What working capital is included? What cash will the buyer need after closing? Are those expectations clearly understood by both sides?

These are questions worth answering before they become problems.

The purchase price gets you the business. Working capital helps keep it running.