Do you have more cash in your business than you really need?  If so, you're in good company.  Many small business owners prefer to keep more cash in their businesses than they really need.  Some keep a cash reserve so they don't have to borrow from the bank or pull money from personal accounts.  They don't want to worry about making ends meet.  Some anticipate a future need for capital and know that cash is more likely to be spent if it goes into a personal account.  Others leave cash in the company simply because they haven't taken the time to decide what needs to come out.  They all figure they can pull out their cash whenever they want.  So, it is not so important to make a precise calculation of the cash reserve they need.

If you keep a fairly large working capital cushion, you might need to rethink your strategy when it comes time to sell your business or allow an employee to buy in. Companies are often expected to pass on their working capital to the new buyer, and working capital includes cash.  Unless you can convince the new buyer that the company has more cash than it really needs, the buyer will want to acquire all of your cash in the purchase.  And since the purchase price will most likely be based on net income rather than asset value, you will not get an increase in the purchase price for the excess cash.

Does it really make sense to sell cash and accounts receivable?  Yes, it does.  When you claim that your business can generate a particular amount of net income, you must give the buyer all the assets necessary to generate that income stream.  If you strip out all the working capital of a business, the new owner will have to contribute additional money to the company so that it can operate, making the business more expensive. 

Buyers and sellers of businesses frequently disagree on the amount of working capital necessary to run a business.  The buyer might argue that the historical working capital of the business is the best indication of what the business really needs.  But the seller might object to that, claiming that more cash was kept in the business than was really necessary.  A good accountant can provide support for your position and may even be able to show typical current ratios for businesses in your industry.  But anyone who has two or more children knows that it is easier to avoid a fight than to break one up.

By stripping out excess cash well in advance of the sale—preferably before the fiscal year closes—you will probably eliminate the conflict.  If the buyer sees it on the balance sheet he will probably want it. By planning in advance you can leave the company will less cash and less room for an argument.  But don't take out too much.  A smart buyer will simply reduce the purchase price by the working capital shortage.

If you are selling a very small business (priced under $1 million) you will probably not have to worry about stripping out cash prior to the sale.  In those business sales, the selling business usually retains its cash and accounts receivable.  That may sound pretty good, but the selling business also remains responsible for the accounts payable and accrued expenses.  In these small business sales the buyer is responsible for providing the working capital that will be needed going forward.

With so many small companies operating as S corporations, there is an even greater chance that a company will have excess cash.  S corporation owners are more likely to keep cash in the company because retention of cash does not affect the income tax consequences to the company or the owner.  Yet S corporation owners strongly resist transferring cash to a new owner when tax has already been paid on that cash.  Owners see that cash as rightfully belonging to themselves rather than the company.  But frequently owners unwittingly sign agreements in which they agree to deliver at closing the same amount of working capital that is reflected on the most recent balance sheet.  This prevents them from pulling out the excess cash, whether or not they have paid tax on it.  When the seller realizes what he has agreed to, he will usually rework the deal, walk from the transaction or suck it up and give up his cash.  And he will regret that he didn't distribute the cash before he started negotiating the sale.

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