Under generally accepted accounting principles or GAAP, working capital is defined as the difference between a company's current assets and current liabilities.

It represents the short-term liquidity available to a business and is a measure of its ability to cover its short-term obligations.

The purchase price of a business includes its assets, and one of those assets is a normalized working capital as agreed between buyer and seller, often known as the working capital target or the peg.

The peg is usually based on an average of historical working capital levels over a specified period.

The peg is designed to ensure that the buyer receives adequate working capital to operate the business and that the seller does not manipulate working capital levels, such as by accelerating receivable collections, delaying payables, and other actions.

Working capital is often handled in transactions through a purchase price adjustment. Just before closing, working capital will be estimated as of the closing, and the purchase price at closing will be adjusted upwards for excess working capital over the target amount or downwards for deficient working capital under the peg.

After closing, there will be a reconciliation process to establish the actual working capital at closing and final purchase price.

Note that working capital is often a source of disputes post-closing, and that the calculation may or may not include cash and the definition under the purchase agreement will often vary from GAAP.

Working capital analysis and the treatment of debt-like items at closing are often interrelated, so it’s important to have a clear understanding of how each works in a transaction.