Hi guys,
I'm valuing a semi-financial institution where people would still use DCF valuation - the issue is that its business incurs bad debt expenses and not sure how to reflect this correctly in FCF. In technical terms seems correct to calc FCF = Net income + D&A + Bad debt expense - NWC - CAPEX , and with NWC calculated by using pre-provisioned receivables.
But the issue is if I increase bad debt the EV as valued by DCF goes UP - Net income goes down by (1-t) of the bad debt expense, but adding back the full bad debt expense afterwards FCF goes up - which seems counterintuitive. ie. if I project bad debt expense as % of revenue, inputting an assumption of 5% would give me a much larger EV than assuming 0%.
Is there a way to somehow justify not adding back the bad debt expense as a non-cash item and still be correct technically?
Interested to know this as well. Seems like when you increase the contra account, your AR goes down hence your -NWC will forever be getting smaller and smaller and value to DCF will be going up
Not a FIGgy, but here are my 5 cents: when you have defaults on your loans, you will take those out of your books against the bad debt (no cash impact). However you will not collect the money either --> negative cash flow impact you're looking for. You cant just build provisions and never use/need them.
Furthermore: you're not adding back the interest, are you working with pre-tax discount rate then? Otherwise double counting for that.
Bad debt expense would also be included in net income, so a higher bad debt expense wouldn’t mean FCF is higher, because it would just be balancing out a lower net income. Changing the bad debt expense assumptions shouldn’t affect FCF.
Explicabo mollitia sed voluptates omnis deleniti iste. Optio facilis quas hic. Et doloremque explicabo distinctio quisquam. Nesciunt molestiae eum natus ut quam amet sed temporibus.
Pariatur reiciendis quia aut voluptates nam. Sit qui illum quia. Animi nihil id totam neque. Molestiae et vel ducimus.
Explicabo blanditiis autem impedit qui qui voluptate et. Deserunt nisi sint iusto error officia ut quisquam corrupti. Occaecati deleniti odit eos veritatis. Rerum corrupti sit velit eos eveniet soluta impedit itaque.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...