Deriving the Free Cash Flow (FCF) for Firm Valuation - Why We Should Include the Change in Non-Operational Working Capital in the Net Working Capital Calculation When Deriving the FCF

23 Pages Posted: 14 Jan 2012 Last revised: 20 Jan 2012

Date Written: January 20, 2012

Abstract

By excluding the change in non-operational working capital in calculating the net working capital for the FCF, analysts create a hypothetical or ‘virtual’ cash flow. This may, or may not, be feasible given the firm’s business plan, as funds may be earmarked for future capex, or other purposes.

If management were to distribute what are in effect ‘restricted’ assets this might also seriously impair the ability of the firm to operate as a going concern.

Lastly, from a consistency point of view, the Cash Flow to Equity is also wrongly inflated leading to other valuation errors.

This note outlines an improvement on the current ‘practitioners’ approach using the free cash flow valuation methodology.

Keywords: discounted cash flows, free cash flow, WACC, net working capital, operational working capital, non-operational working capital

JEL Classification: G12, G32, M40, M41

Suggested Citation

Stockfis, Robert Richard, Deriving the Free Cash Flow (FCF) for Firm Valuation - Why We Should Include the Change in Non-Operational Working Capital in the Net Working Capital Calculation When Deriving the FCF (January 20, 2012). Available at SSRN: https://ssrn.com/abstract=1984328 or http://dx.doi.org/10.2139/ssrn.1984328

Robert Richard Stockfis (Contact Author)

affiliation not provided to SSRN ( email )

Register to save articles to
your library

Register

Paper statistics

Downloads
484
rank
56,686
Abstract Views
1,933
PlumX Metrics
!

Under construction: SSRN citations will be offline until July when we will launch a brand new and improved citations service, check here for more details.

For more information