working cap and cash
Hi all,
Just want to confirm my understanding of the correct treatment of working capital and cash in a DCF calculation.
The assumptions are:
1) Forecast balance sheet has been provided with various types of current asset and current liability items;
2) The company also possesses a decent amount of cash.
My questions are:
1) In calculating the forecast the working capital balance for DCF analysis, is the correct approach to base it on Current assets (excluding cash) – Current liabilities;
2) In addition, should forecasts of working capital balance always exclude cash – I am asking this because I have come across models where the analyst has forecast the balances Cash, AR, Inv and AP by multiplying their current balances by the increase/decrease in turnover;
3) And, if the forecast working capital balance excludes cash, does it automatically imply that the cash balance is excess cash and should be treated as a surplus asset to derive the equity value? I am asking this because I have seen models where the forecast working cap excludes cash and treats the cash as a surplus asset and models which assumes the cash is operating.
Thanks.
Not quite sure where the confusion arises from. Cash is balance sheet. Cash flow statement is the reconciliation of where the change in cash arises from. Of course you cannot model out a complete cash flow statement due to too many unknowns from CFF, and CFI so people will estimate the cash on the balance sheet.
Answer is it all depends on the company. McKinsey says 20% of cash is deemed "operating" and thus must be used in calculating WC, with the remainder "excess". Is the company likely to draw on cash reserves for a major capital project? What are the operating vs non-operating cash percentages of industry peers?
Valuation really is more art than science..
I suppose I am just trying to confirm the appropriate treatment for the following scenarios:
a) Hypothetically, 100% of cash is operating
In this case, when I project the future working cap balances from the projected balance sheet, should I simply sum up (Current assets (incl. cash) - Current liabilities), and since all the cash is operating, I will not add the current cash balance to the enterprise value and deduct debt to derive equity value;
b) Hypothetically, all cash i non-operating
In this case when I project the future working cap balances, should I exclude cash in my equation (Current assets - Current liabilities), but add cash to Enterprise value and deduct debt to derive equity value.
Is my understanding correct?
Thanks.
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