If a company has had net working capital levels of approximately 12% of sales over the past
Question:
If a company has had net working capital levels of approximately 12% of sales over the past five years, it can be reasonably estimated that the company will continue to require that level of working capital to support future sales. Therefore, it may be appropriate to add any working capital amount in excess of 12% of sales as of the valuation date to the determined company value as excess working capital (essentially a non-operating asset). A related adjustment may be made that would reduce the company's value for deficient working capital if the company had a net working capital balance below its historical levels as of the valuation date.
Company Z has $1.2 million of net cash flow (NCF) for simplicity purposes let's assume for the industry a valuation multiple for NCF is 4.0 so we have $4.8 million Entity Value
Working Capital of $1.5 million, of which is $500 thousand, is considered a working capital surplus and therefore is added to the purchase price.
$4.8 million Entity Value plus $500 thousand excess working capital = $5.3 Million value.
Does the excess cash represent a return on the seller's investment? From a valuation standpoint, theoretically, if we used the discounted cash flow method or capitalized cash flows method we would arrive at the same $4.8 million value, didn't we use the same cash as part of the valuation of cash flows? Is this a double-dip?
Entrepreneurial Finance
ISBN: 978-0538478151
4th edition
Authors: J . chris leach, Ronald w. melicher