Hello All, I’m looking at the EV/EBITDA multiple and I can’t for the life of me understand why cash and investments need to be subtracted. If I’m buying a company, their cash and investments can be quite significant, and I can’t understand the point of removing them from an acquisition price. Thanks in advance! Ryan
You are essentially buying cash. Lets say I have a company with 2 assets–a machine worth $100 and $1500 in cash (for simplicity this is the only thing on the balance sheet). If you are willing to pay me $1600, you end up with a $100 machine and $1500 in cash. In effect, your transaction was just a $100 purchase of a machine, as post-transaction you still have $1500 in cash. As such, you can deduct the cash of the acquired company when looking at EV–you want to buy something of value, what point would there be to buying cash? Does this make sense?
Imagine yourself buying a drink for $10 with a $5 note attached to it. What the net transaction after removing out the redundat transaction? - The drink cost you $5, right? (because you spent $5 extra to get that $5 note attached - so effectively you nulled out)
It’s the same as offering to buy someone’s $5 bill with your $5 bill. You’re just trading equal amounts of money and there is no actual value changing hands.
thanks guys and gals. That makes perfect sense explained like that…
One of the drawback of EV/EBITDA is 1. If working capital is growing, EBITDA will overstate CFO. What are they trying so say here? Can someone elaborate this with numbers?
When Working Capital increases - this means CA - CL > 0. When CA - CL > 0 – Net Current Assets are increasing - this means that CFO will be reduced by that amount. When you look at EBITDA - you only have COGS being reduced there. There are AR increases and other things in CFO - not considered in EBITDA. So EBITDA will overstate CFO.
Super duper. Thanks cpk. Such concepts don’t come back to me since my FSA fundamentals are crap.
One way of looking at it - EBITDA excludes interest. So to make the ratio consistent you’d want to remove interest from the numerator also. So cash must be subtracted cos cash generates interest also.
Enterprise value is a very elusive term, essentially tries to capture how much is the business worth. Conceptually you should add its MV of equity+all other sources of non-equity financing. An easy and non-too complicated formula I usually use in practice is: Enterprise Value= Market cap+Net debt (this already subtracts cash)-minorities-other obligations treated as debt (eg pensions)+non-core assets. There exist however tons of different versions of this formula…
Enterprise value is a very elusive term, essentially tries to capture how much is the business worth. Conceptually you should add its MV of equity+all other sources of non-equity financing. An easy and non-too complicated formula I usually use in practice is: Enterprise Value= Market cap+Net debt (this already subtracts cash)-minorities+other obligations treated as debt (eg pensions)+non-core assets. There exist however tons of different versions of this formula…
Enterprise value is a very elusive term, essentially tries to capture how much is the business worth. Conceptually you should add its MV of equity+all other sources of non-equity financing. An easy and non-too complicated formula I usually use in practice is: Enterprise Value= Market cap+Net debt (this already subtracts cash)-minorities+other obligations treated as debt (eg pensions)-non-core assets. There exist however tons of different versions of this formula…
Thx HR & memalos. Should’nt it be ‘+’ minorities?
Ofcourse its + minorities. Somehow, whatever I write gets posted times three. I think that apart from making me look like a complete douche, it might be a leading indicator of exam failure…
cpk123 Wrote: ------------------------------------------------------- > When Working Capital increases - this means CA - > CL > 0. > > When CA - CL > 0 – Net Current Assets are > increasing - this means that CFO will be reduced > by that amount. > > When you look at EBITDA - you only have COGS being > reduced there. There are AR increases and other > things in CFO - not considered in EBITDA. So > EBITDA will overstate CFO. CA-CL>0 just means the working capital is positive, it does not mean that it is growing. it can be positive and still decreasing. also if working capital is growing, that doesn’t necessarily mean current assets are increasing. maybe CA are decreasing but CL are decreasing even more. CFO = NI + DA - Change in WC EBITDA = NI + Taxes Paid + Interest Paid + DA so if WC is growing, Change in WC is positive. You can see by comparing the two equations above that EBITDA>CFO