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There are many variations and slightly different definitions of Working Capital, but we really only care about the one used on the company's Cash Flow Statement and in the FCF/UFCF/other projections in valuations. Which, yes, technically is Net Operating Working Capital, but we think it's silly to distinguish between NOWC vs. OWC vs. WC (for example) when only NOWC is relevant for modeling/valuation.
Great video. Thanks for sharing. Could you please tell how to find example docs (i.e. valuation summary) you showed? Seems to be archives from sec edgar. Thanks
You can search Google for the relevant keywords and limit your site search to sec.gov. There's a bit more to it than that because you can also restrict by dates and so on, but you normally do that and use Image Search to quickly scan the results.
It was replaced years ago, sorry. We have many examples of 3-statement models from templates vs. blank sheets in the courses and occasionally post free samples here.
With this method the min cash can go below 5% of sales... how should it be handled? If free cash flow or Net income decreases the ending cash will go below the required 5%. How should it be handled
As mentioned in the other comment response, this would be handled in real life via a Revolver to draw on extra funds if the company falls below the Minimum Cash. There is no requirement to build one into this model, so it's not shown here.
Hi, one thought, if the Free cash flow decreases year 1 to e.g., 10 (instead of 44) then we have Ending cash of 23 which is lower than the minimum cash. How can that be? From my understanding, we all the time need to have 5% min cash to sales in cash?
You normally handle this with a Revolver that allows for additional borrowing to meet the Min Cash, which is not included in this simple 60-minute example. You shouldn't really worry about edge cases and strange behavior in models in an extreme time-pressured case. This is more something to worry about if you have more time / need a more robust model that includes different scenarios.
Hey Brian, could you share your thoughts on the CFA certification, what it entails, and whether you think it's worth the time for someone considering a career in finance/investments?
We've covered this topic many times: mergersandinquisitions.com/cfa-for-investment-banking/ mergersandinquisitions.com/investment-banking-certification/
Thanks! Project IRR is just the IRR as if there's no leverage used, so you remove the debt, interest, principal repayments, etc. It should be lower for projects that perform well.
Files & Resources: breakingintowallstreet.com/kb/project-finance/debt-service-coverage-ratio/ breakingintowallstreet.com/kb/project-finance/loan-life-coverage-ratio/ Table of Contents: 0:00 Introduction 0:42 The Short Version 4:30 Part 1: Debt Sculpting and Sizing Uses (Quick Review) 6:28 Part 2: Additional Items and Complexities 9:24 Part 3: Variable Dates and Discount Rates 11:22 Part 4: Multiple Debt Tranches 12:51 Part 5: The DSCR and LLCR in Covenant Analysis 14:47 Recap and Summary
Yes, because PP&E is considered an operational or core-business asset. Spending cash on PP&E will keep Equity Value the same since Net Assets stays the same, but will increase Enterprise Value since Net Operating Assets increases.
Very helpful video, thank you. One question, for the sensitivity tables, I seem to always get 0 values or one repeating value. I checked the circular references, locked the reference cell properly, put on automatic calc mode.. Do you have suggestions what else could be an issue? I use mac, Excel 2016 version. Thanks!
It's either a problem with the table or a problem with your model links. Start by changing these assumptions in the model and seeing if the IRR changes. If it does not, it's an issue with how the assumptions are linked in your model. If it does, it's a problem with the table - try hard-coding each value in the left column and top row and delete and recreate the entire table with the correct row and column input values.
Hi Brian, thanks for the great video, super useful! Quick question on the revenue recognition (around 5:00): is it triggered by the booking or the billing? I.e., in your example, booking and initial billing take place in the same month however in practice, it is not unusual for company to have a book-to-bill gap. If we assume that this gap is one month, so bookings $120 takes place in month 0 and billings $60 take place in months 1 and 7. Would revenue $120 still be recognised between months 0 and 11 (i.e., jan to dec) or between months 1 and 12 (i.e., feb to jan)? thanks in advance for your response :)
Revenue recognition corresponds to invoices under GAAP rules (so billings, not bookings). If there is no billing until Month 1, revenue recognition starts in Month 1.
Hey could you please clarify on what the company means especially when they talk about their total working capital requirement? Is it the current operational assets - current operational liabilities or just the change in working capital. I have seen companies reporting that their total working capital requirement is current assets - current liabilities and let's say 80% will be funded by short term borrowings. How do I make out of that statement? Pls clarify
It depends on the context, but usually "Working Capital requirements" refers to the actual Working Capital number, i.e., current operational assets - current operational liabilities. Assuming that it's positive, something must balance it on the L&E side of the Balance Sheet, which may be short-term borrowings. But all of this is a bit silly because what really matters for cash flow is how the WC changes over time. If there's some huge increase in a short period, companies might have to fund that with additional borrowings.
It can be useful to benchmark one property against others in the area or the overall average, or to see how Cap Rates for that property or similar ones have changed historically. But this approach is much more common if you use precedent real estate transactions to value a property, as you'll have to back into the Cap Rate based on the market value and NOI there.
@@Walina-gv9ph You buy a house for $500 per square foot. Other homes nearby cost $300 per square foot. You got a bad deal. It's the same with Cap Rates. If you buy at 8%, but other similar properties nearby have sold for 10%, you got a bad deal.
Nice video. But when your doing a DCF aren't you supposed to subtract change in net working capital so if the change is negative it will become a positive number and if the change is positive you will subtract that number? The way i learned it was Negative Change in NWC ➝ More Free Cash Flow (FCF) vs Positive Change in NWC ➝ Less Free Cash Flow (FCF). Is that correct?
No. If Working Capital increases, the Change in WC on the CFS is negative, so it reduces cash flow. Think about a company purchasing Inventory using cash. If Working Capital decreases, the Change in WC on the CFS is positive, so it increases cash flow. People always mix this up because the signs are *reversed* on the CFS, so you use Old WC - New WC to calculate the change. It's the opposite of what you would do outside the financial statements.
Files & Resources: breakingintowallstreet.com/kb/real-estate-modeling/cap-rate/ Table of Contents: 0:00 Introduction 0:37 The Short Version 4:44 Part 1: What Affects Cap Rates and How to Find Them 6:58 Part 2: Cap Rate vs. IRR vs. “Cash Yield” 9:19 Part 3: Cap Rates in Real Estate Models 11:17 Part 4: Cap Rates in REIT Models 12:12 Part 5: Cap Rates Variations, Controversies, and Trickery 15:16 Recap and Summary
Hi! Thanks a lot for this guide! I'm really confused about NI calculation in 3 forms though. Is it really ok that in case of negative EBT we still account for tax expenses (in this case it will be positive and will be "tax refund"). I mean if we have EBT of (-$100) that's just it, right? Why should we make $(-(-40)) of tax and use this unrealistic 60$ of Net Income? Shouldn't the Net Income be just (-$100)?
Some companies do not do this on their actual financial statements, but this practice makes it much easier to set up and links financial models, which is why we use it. But some companies would just record $0 for their Taxes in real life in this case.
@@scool1018 There is not really a good way to do it otherwise. You'd have to somehow link the DTA to off-statement changes or a separate schedule to set it up, which is not recommended.
Sorry, but we generally do not revisit analyses or valuation from older periods, as it is a huge amount of work for very little gain. The valuation here was completely correct for the first ~12 months after the IPO, which is the typical target date / time frame for stock pitches in most fields.
The calculation is incorrect because when you multiply the tier 1 ratio with the RWA you get the total tier 1 capital (CET1 AND AT1) thats not shareholders equity, the approach should be different
This is a video from over a decade ago before the Basel III rules went into full effect in the 2015 - 2019 period. Please see the recent regulatory capital / Silicon Valley Bank video from last year for more recent treatment of this topic. The approach shown here is deliberately simplified / needs to be adjusted today, but the basic principles are still true (i.e., back into the allowed dividends based on the regulatory capital targets and net income generated in the period).
I love your videos. I got my master from a good ranked European school, but we only did theoretical finance. Nothing related to what you do at work. These videos are really an eye opener, and the quality is superb. Thanks a lot!
Great video thanks Brian! A follow up question: to calculate levered FCF under US GAAP a quick way would be to take cash flow from operations and minus capex. Under IFRS with leases, would the equivalent be cashflow from operations - capex - lease repayment (under cash flow from investing activities)?
Yes, that method would work under IFRS, but it actually calculates Free Cash Flow, not Levered Free Cash Flow. Another approach is to still use Cash Flow from Operations minus CapEx, but *exclude* Lease Depreciation from the Total Depreciation figure added back within CFO so that FCF figure deducts Lease Interest and Lease Depreciation, which should roughly equal the Lease Interest + Lease Principal Repayment, AKA the total cash lease expense.
Great video ! From my understanding, the only issue with VBA is that you can’t build sensitivity tables since they don’t run VBA code. Is that correct ? Do you know what is the alternative ?
That is a downside to VBA in models, but you can get around this issue by building the sensitivity table manually using VBA. It's not that complicated, but it does take more code than you might think because of the way VBA works (there are a few examples in our Project Finance course).
To find the opening and closing balance of trade receivables, do we take the figures from the balance sheet which says trade and other receivables?, or do we check the notes part of the annual report and take the figure under trade receivables?
It's best to use the Balance Sheet figure to get the total amount of Receivables. The only exception to this is if the company also offers financing to customers and has receivables associated with that, you could argue that it's better to exclude those and focus just on the receivables associated with product payments, not financing. But then that gets into a discussion about what is actually "core" to the business, which gets complicated and is probably not necessary for a quick analysis like this one.
Hey Brian, one quick question. Does the risk-free rate period has to adjust the dcf projection period? For instance use the 5y T-note yield for 5y projection or 10y bond yield for 10 year projection and so on? Thanks.
In theory, yes, but most people just ignore this and use the 10-year government bond yield for the Risk-Free Rate in most analyses. Unless there is a massive difference between the 5 and 10-year yields, it's usually not a big deal.
As a Student of Management Accounting and interested into Finance, I love how you use REAL FINANCIAL DATA from companies. Most don't do these in their tutorials. Please, keep doing more of this real case studies. It helps me down in the long run. You just earned a new subscriber. Much Love.
Hi, thanks for your effort as always. I have a question regarding on working capital calculation. Should I reverse all the signs of the working capital section since increase on inventories is cash out while increase on liabilities is cash in? Or should I just calculate it as stated in the statement? Having a hard time to understand this. Thank you.
The Cash Flow Statement shows the correct signs as-is for all the Change in Working Capital line items, so you should go by that. Do not attempt to reconcile the historical line item values to the "Change" values shown on the CFS, as it will never work due to issues like companies grouping items differently on the statements.
It's not a required step. We just did this as a reference / comparison to check the purchase multiple against the exit multiple. But we could have stopped at the 1,150 purchase price.
Hi Brian thanks for this video ! One question: In the year when a LT debt is to be repaid in full, does the amount appear in the P&L as a financial cost, or in the CFS under a "debt repayment" item ? I guess it depends what's our starting point in the CFS, i.e. Net Income or EBITDA ?
Debt repayments of any type should always appear on the CFS. The starting point doesn't matter because it's still a cash outflow that never appears on the Income Statement.
@@financialmodeling Thanks for the answer, but then I don't really understand the difference of treatment with the preferred dividends for instance. The debt repayment will impact common shareholders' dividends isn't it ?
@@cyrokkk Preferred Dividends do not impact the Preferred Stock balance unless they are accrued. They just represent a simple payment in the period for the cost of using Preferred Stock in that period. With Debt Repayment, there is no direct impact on the company's Common Dividends because most Dividend policies are set based on Net Income or per-share targets. You could argue that they do make an indirect impact by reducing the total cash flow available for Dividends, but even if that is true, they do not meet the first condition (that they correspond to something only in the current period), as Debt Repayments affect the future Debt balance that needs to be repaid and even the future Interest Expense.
After 10 years in Finance, I’ve learned that accounting is the tool that poor performing companies use to make themselves look good. It’s completely arbitrary. The only reason to learn accounting is to find out what a company is hiding. There’s such a huge difference between financials and cash flow based on bank accounts, that financial reporting by accrual accounting is virtually useless.
Like any tool, accounting may be used correctly or incorrectly. Not all companies hide secrets, but some do. But they cannot hide them everywhere, which is why the Cash Flow Statement exists and why the best analysts also read the footnotes, special items, etc., and do their own due diligence.
@@financialmodelingAgree the cash flow statement is the way to go, however, the traditional cash flow statement based off of the other two financial reports is virtually useless. The only beneficial cash flow statement is one built, using the direct method based off of revenues and deposits and operating expenses. Once you see their operating cash flow is consistently negative, you know the business is in trouble. They’re either operating off debt or cash injections. Meanwhile, the income statement still shows a positive net income, which is total BS.
Files & Resources: breakingintowallstreet.com/kb/accounting/income-statement/ Table of Contents: 0:00 Introduction 0:39 The Short Version 5:43 Part 1: More Advanced Line Items 7:24 Part 2: Why Does Item X Appear on the IS? 9:50 Part 3: Income Statement Forecasting 11:46 Part 4: The Income Statement in Interviews 14:10 Recap and Summary
Hey Brian, hope you are doing well. I have a question for you regarding the specific multiple that should be used for valuing a private company in an LBO scenario. If you're tasked with finding the entry multiple to pay for LTM EBITDA for a private company and you're given an output of comps (trading or precedents), should you always use the median multiple?
You could use higher or lower multiples (e.g., 25th or 75th percentile) if the company is performing better/worse than the median of the set. But you would need some pretty good justification for this because most people just expect to see the median used.
Book Value is Common Shareholders' Equity on the Balance Sheet. Market Value of Equity is the company's market cap or Share Price * Shares Outstanding, which is usually much higher because the market value of most companies' Assets - Liabilities far exceeds the historical numbers shown on the Balance Sheet.
The difference between book value and market value in Equity Value is that book value represents the accounting value of equity, while market value reflects the current market price of shares.
OID amortization should, in theory, be straight-line, but if there are early/optional principal repayments, it will be accelerated in proportion to those repayments. None of this really matters in models because OID amortization is non-cash and barely affects the taxes. So in practice, most people just simplify and assume straight-line amortization if it is required at all.
Can you explain when the concept of EO comes into play in bargain purchase? I recently came across a bargain purchase transaction in my firm where a hospital was acquired at less than its book and fair value of assets. My manager’s view was that this is a case of EO, so we had the fixed assets (FA) of the target revalued at their post EO values which basically meant that the capital asset team revalued the FA to such a number where the total of FA + NWC reconciled with the purchase price paid (BEV) for the target. In short, we recorded zero goodwill and no intangibles while reducing the FA numbers. But I’m confused whether this method is correct or not and how the acquirer would actually record this in its books because we didn’t show any gain on bargain purchase in our valuation report. Thanks!
