Are you willing to expand the operations of your company through debt relief services and you have found the perfect bolt-on business? The corporate financial advisers of the seller have proposed that the deal is structured on a Debt Free Cash Free basis. But what does this actually imply?
Debt free cash free (DFCF) is a valuation method as well as a debt relief program of the focus company during a transaction of the acquisition. The DFCF valuation accounts for the business value and is exclusive of financial impacts of net cash or net debt that existed during the process of closing.
Explanation to the Theory
The calculation of DFCF is a standard of measure brought into use for merger and acquisition transactions in order to arrive at a price of purchase as well as debt relief. During the process of due diligence, the target company and the acquirer have to make out which items are considered cash (to illustrate, customer deposits) and which items are considered a debt (for instance, tax obligations). Then the target company disburses off all the debt and keeps all the remaining cash. Once the debt free cash free valuation is decided upon, the final agreement of purchase is drawn up and the deal transaction becomes outright.
Several advantages are there in the usage of the valuation of debt free cash free. The focus company is provided with a basis in which doing comparison of all received offers. Additionally, it permits the acquirer to concentrate on the business value as all of the financial trends of the target company remain the same while the cash and debt fluctuates during the process of closing.
Value Determination of Debt Free Cash Free
This article of Continuous Professional Development (CPD) does not concentrate on the valuation of business, but the answer of the highest possible level on the way the debt free cash free is determined is dependent on the realization that businesses are often valued by the multiplication of the earnings to get debt relief solutions. A purchaser might fetch the earnings of a business and multiply those to calculate the value of debt free cash free (DFCF) used in the offer letter.
- EBITDA x multiple = DFCF value. Debt free cash free implies the value of a business assuming its banks’ claims were removed magically. Debt free cash free is a business’s value prior to taking account of the net obligations owed to banks. As per the consistency, during business valuation by multiplying earnings, our valuation is requisite of utilization of an earnings figure that is even exclusive of banks’ claims, such as Earnings Before Interest, Tax, Depreciation and Amortization (EBITDA, which is a pre-interest measure of earnings). Here, the consistency is that, application of an appropriate multiple to pre-fiscal incomes proffers an appraisal before banks’ claims on the business: the debt free cash free value.
- DFCF value less net debt = shares’ value. The route from debt free cash free to shares’ value is something what is anticipated by the seller to receive. The net debt could be subtracted from the debt free cash free value to get the shares’ value.
- Optionally, a slightly diverse route could be taken straight to the shares’ value by taking a post-fiscal incomes figure like Net Profit After Tax (NPAT) and application of an appropriate multiple. NPAT x multiple = shares’ value would be provisional with an appraisal subsequent to banks’ claims on the business.
This is not a detailed explanation of appraisals, but the very essentials are laid out above to ascertain credit debt relief. The most imperative point is that EBITDA x a multiple = debt free cash free valuation. A buyer could conduct some research into values that other businesses had sold at or values other businesses were trading at in the stock market, obtaining a multiple for comparable companies.
Then the buyer might apply that multiple to EBITDA earnings for the comparable business and make use of that to provide assistance to them in the decision of what the debt free cash free offer ought to be.
The bridge in the midst of debt free cash free and shares’ value is net debt, even if there is another way of getting there too.
Those who have studied fiscal studies formerly, are bound to make out the resemblance in the midst of debt free cash free value as well as enterprise value. Both measures value a business by the exclusion of some of its liabilities. This causes the similarity between the two measures of value.
The diversity is that some valuation practitioners would be inclusive of a few more liabilities as a part of their calculation of enterprise value, like the items that may not bear interest but are still having to be financed, such as a pension obligation.
To summarize, the valuation method of debt free cash free:
- Is representative of the value of a business with net debt eliminated;
- Is greater than shares value/consideration for a business, having net debt;
- Is frequently in use in letters offering to buy a business; and
Is very much analogous to another term brought into use in finance: enterprise value.
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