Note: click on the video below to play or, alternatively, if you prefer you can read the course transcript underneath.
What is a debt free cash free valuation?
[Transcript begins] What are we thinking debt free cash free means? It’s free of debt and cash isn’t it? The clue is in the question. What is it? Free of debt and cash. Let’s understand that a bit more. Debt free cash free. And here we go, we’re answering that question: what is it?
Debt free cash free valuation chart
I’m going to try and answer it this way for you. We know it means free of debt and cash, let’s unpack that a bit more. If I tell you Linklaters, there’s a lot of confusion sometimes when I’m talking to lawyers, and particularly amongst clients, about what this actually means. So what I’m going to do is draw a little chart here. You might want to copy this into your packs somewhere. This chart on this side here.
Delegate: Mark, Mark, sorry, sorry, sorry. You’re going to have to try to do that a little bit softer so that it doesn’t make that noise please.
Training course provider: I wish I could. I wish I could. Let me try this one. It might be better.
Debt free cash free and shares value
OK. Over here [points to RHS], I’ve got something called the shares value. The shares value. The value of the equity in the company. Over here on the right hand side we’ve got the value of the shares the equity in the company.
Free of debt valuation increases
Now, a lot of companies, I’m sure it’s the same in Portugal as it is in the UK, have debt: right? They owe money to the bank: yeah? Not a controversial issue there. Lots of companies have debt. I want you to imagine, and again I’m not trying to trick you. I’m not trying to trick you.
[Aside] Do you know what Andre…
Training course provider: I want you to imagine a company. It’s got some value in the shares. It’s got debt. It’s got debt. Nothing controversial there. Now what I want you to do is imagine a fairy godmother. Do you have fairy godmothers in… you have fairy tales? Fairy godmother, OK, you know what I’m talking about. She waves a magic wand and she magically takes away the debts of the business. So, fairy godmother, comes along, waves a magic wand. By the way guys just remember before you start relaxing, we’ve got our little valuation exam. These things will come up again.
Debt free cash free value is higher than shares value
Right, a fairy godmother waves her wand over the business, waves her wand over the business, magically takes away the debts. What are we thinking has happened to the shares value? Who should I pick on?
Delegates: it will increase.
Training course provider: Ah you guys are smart. We’ve saved ourselves a lecture. So, here we go. Just to complete the chart, what we’ve got here [points to LHS] is the debt free cash free basis.
Net debt definition
The bankers and corporate finance advisers, when they’re looking at this piece of the puzzle [points to middle of chart]... remember we were working from here [RHS] saying to ourselves: “What would this business be worth free of debt?”… the banker will often look something called net debt. Again, it’s not a trick question. What are we thinking Linklaters, what’s net debt? Does anybody think they know?
When we’re focusing on this piece of the puzzle here (the middle), a banker or somebody in valuation would often focus on net debt. And that’s debt less… in fact I could be even more prescriptive, and say “surplus cash”.
So to get to the debt free cash free value from here [RHS] what they would do is imagine that the fairy godmother has magically taken away the net debt, magically taken away the net debt (and net debt is debt less surplus cash), to get back to the debt free cash free value.
Important note regarding this CPD course material
Most professionals who are in legal or accounting practice are required to complete a minimum number of hours of CPD training per year, with CPD requirements determined by their professional body. Financial Training Associates makes a certain proportion of free CPD course material available without charge online. Solicitors, law and accounting professionals are encouraged to assume responsibility for their own development and choose from a wide range activities relevant to their responsibilities and development needs. In some cases a proportion of the CPD requirement can be met through self study. Depending on the CPD requirements of your professional body (e.g. ACCA, ICAEW or SRA*), you may be able to credit the time spent studying this CPD course material against your CPD obligations. This CPD module is not explicitly accredited for CPD points with any particular professional body.
*ACCA = the Association of Chartered Certified Accountants, ICAEW = the Institute of Chartered Accountants in England and Wales, and SRA = the Solicitors’ Regulation Authority.
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