Being free of cash can make you wealthier

Source: wikipedia.com

When companies are sold, the consideration is often adjusted for what’s happening in the balance sheet. A company has assets, such as outstanding invoices by customers or fixed assets such as computers. It also owes money to suppliers, the government for taxes and so on. It’s logical that the buyer pays the seller for these assets. Logical perhaps, but wrong.

Instead, most transactions are done ‘cash & debt free’, where the seller repays the company’s debts but keeps any surplus cash. The buyer gets to keep the customer invoices, assets and so on. The best way to understand why this is the right way is to simplify balance sheet.

This is the conventional view of a balance sheet, which frankly is not very helpful, because it implies that the buyer should pay for the equity (being the assets minus the liabilities, or the company’s book value).

Let’s simplify the balance sheet:

· Working Capital = Current Assets — Current Liabilities

· Net Working Capital = Working Capital — Cash, So…

· Cash + Net Working Capital + Fixed Assets = Equity

Valuations are based on the company’s ability to generate returns for shareholders — the net present value of all future dividends and capital returns, to be precise — not how much money is tied up.

The fixed assets and Net Working Capital are needed to run the business: the former being the equipment, fixtures and fittings that are used, and the latter the capital tied up in the process of providing goods and services to customers. So buyers won’t pay for either, but in most M&A deals, the seller gets to keep any surplus cash, explaining why most deals are done ‘cash and debt free’.

One clap, two clap, three clap, forty?

By clapping more or less, you can signal to us which stories really stand out.