Calculating operational cash flow

Calculating the net cash value of the operational cash flow

A cash flow statement provides an insight into a business's liquidity. Calculating the operational cash flow clarifies to what extent a business has been able to convert recent results into liquid assets, taking account of depreciation is and changes in value of the floating assets and short-term debts. Calculating the operational cash flow which can be paid out in the future to providers of loan and equity capital is also the basis for determining the value of the business in accordance with the various Discounted Cashflow methods.

Calculating the operational cash flow

The Discounted Cashflow methods are valuation methods which focus purely on the future. These methods are based on the assumption that the value of the business is equal to the net cash value of the free operational cash flows which will eventually be paid out to the providers of loan and equity capital in the future. When using these methods the idea is to translate the vision into the future into forecasts for the years ahead, with a distinction being made between the explicit forecast period and the residual value periode. These forecasts are used as a basis for calculating the free operational cash flow which becomes available from the company's commercial activities in combination with additional investments in working capital and investments in fixed assets. The operational cash flow is calculated as follows:

Operating result (EBIT)

+/+ Depreciations

+/+ Changes to provisions

-/- Operational taxes    

Gross operational cash flow

-/- Additional investments in working capital

-/- Net investments in fixed assets

Free operational cash flow

Calculating the net cash value of the operational cash flow

The free operational cash flow determined in this way is discounted according to the time of valuation. The discount rate is determined by the weighted return requirement which providers of loan and equity capital will reasonably impose on the company.

The residual value is the value of the free operational cash flow after the specific forecast period. When determining the residual value it is assumed that the business has reached a stable phase and that the investments no longer create any additional value, taking account of the general growth rate of the economy. The residual value is then equal to the calculated free operational cash flow in the first year after the forecast period divided by the discount rate. After that this residual value is discounted according to the time of valuation.

The value of the forecast period and the residual value obtained by calculating the net cash value of the free operational cash flow together form the business value. Lastly, in order to calculate the value of the equity capital per time of valuation, the market value of the interest-bearing debts will be deducted and any excess liquid assets will be added to the business value.

Do you want to have your business valued by Sophista?

Valuing a business on the basis of a Discounted Cashflow method requires proper preparation. For example, a detailed business analysis needs to be carried out and reliable forecasts need to be drawn up for the calculation of the free operational cash flow. The Sophista team would be only too pleased to help you with this. If you have any questions you can always contact André Scheirlinck.

 

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