Deferred income - Debt-Like
Friday brain fog….
I always push for deferred income liabilities; where cash has been received in advance of recognising the income to be treated as debt-like.
As the buyer will need to deliver the service and the Target had not ‘earned’ the cash under the seller’s ownership.
However I’m having brain fog….
The target has £100k of deferred income. This will result in their cash been £100k higher with a corresponding £100k deferred income liability.
I buy the business for £1m (EV). I give them an additional amount for cash at completion £200k (for which £100k relates to the deferred income received). I treat the deferred income creditor as debt and this is all the debt the business has. Therefore £1m + £200k cash less £100k debt = £1.1m
The net impact of the deferred income adjustment is 0 as cash increased by £100k which is offset by the debt adjustment.
After completion when I deliver the project I won’t get paid as the cash has already been received - therefore I am technically out of pocket - as the adjustment above is nill.
It is not captured in WCAP either as the closing WCAP will increase by £100k (by classifying deferred income as debt and adjusting out) but the target will also increase as deferred income will be adjusted out the target on a like for like basis.
Problem with that logic is that deferred revenue doesn’t come all at once in a single point in time - your scenario basically assumes all deferred revenue zeroes out at some point and the business receives a large inflow of cash which is not how deferred revenue typically is accounted for in normal business operations
In any case - cash free, debt free: the benefit of the deferred revenue as a debt-like item only makes sense if cash is excluded from working capital and the debt if the cash balance is assumed to be 0. Your scenario seems to assume that an actual cash balance will be delivered at closing (rarely happens in practice, and if it does, there is most likely a provision in the SPA that prevents double dipping)
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