Net Operating Working Capital (NOWC)
Definition - What does Net Operating Working Capital (NOWC) mean?
Net operating working capital or NOWC is calculated by taking the current assets required in operations and subtracting non-interest bearing liabilities. NOWC helps assess a company's liquidity because it looks only at current assets and liabilities required to operate the business. Current assets typically include cash, accounts receivable and inventories, but exclude marketable securities. Current liabilities typically include accounts payable and accruals, but exclude short term debt.
Divestopedia explains Net Operating Working Capital (NOWC)
Buyers are particularly interested in understanding what a target's average net working capital is. The reason for this is that buyers want to understand how much working capital a target needs to sustain the revenue and free cash flow used to calculate the enterprise value. The only difference is that buyers often exclude cash from the calculation since it is assumed the seller will remove all cash prior to completing the transaction.
Buyers often peg a certain level of NOWC to be part of the net tangible assets left in the business. For example, assume a target has revenue of $10 million, EBITDA of $2 million, and average NOWC of $500,000 over the last 12 months. A buyer is looking to buy this business at a multiple of 4x TTM EBITDA of $8 million. The company has capital assets required to operate the business with a fair market value of $3 million.
The buyer may write into the purchase and sale agreement the requirement for tangible asset value to be no less than $3.5 million (the capital assets + the average NOWC), with any amount or below at closing adjusted dollar for dollar from the cash consideration. this is because if NOWC is less than the average of $500,000, the buyer knows that an additional investment (in the form of equity or debt) will be required to build up the NOWC to its average in order to sustain the $10 million of revenue.