Answers / Financial Due Diligence
How do you set the net-working-capital peg for a seasonal business, and what's the trap with a simple 12-month average?
A core Financial Due Diligence interview question — asked in analyst and associate interviews across IB, PE, and the Big 4.
THE SHORT ANSWER
For a seasonal business the closing-date NWC swings widely, so the peg must reflect the normal level for the business at the expected completion date — not a single point. The right approach is to model the monthly NWC profile over at least 12 months (ideally 24-36 to confirm the pattern), understand the seasonal drivers (inventory build before peak, receivables after), and set the peg to the level appropriate for the actual completion timing. The trap with a naive 12-month average is precisely that it can mislead: if completion falls at a seasonal peak or trough, the average understates or overstates the cash the business genuinely needs, handing one party a windfall — so an average is only valid if completion timing is itself average/uncertain. Where timing is known, peg to that point on the normalized seasonal curve; where uncertain, a collar around the average can protect both sides. I'd also normalize out any one-off or stretched-payables distortions before fixing the level.
WHAT INTERVIEWERS LISTEN FOR
- ✓Peg = normal NWC for the business at the expected completion date
- ✓Model the monthly seasonal profile (12-36 months), not a single point
- ✓Trap: a flat 12-month average misleads if completion is at a peak/trough
- ✓Peg to the point on the normalized curve; use a collar if timing is uncertain
COMMON MISTAKES
- ✗Defaulting to a 12-month average regardless of completion timing
- ✗Ignoring the seasonal curve / completion date
- ✗Not normalizing one-off or stretched-payables distortions
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