Quick Question about DCF Construction

September 26, 2022

by a searcher from University of Tampa in United States

Hi all,

When calculating the increase in NWC, do we take cash and short-term investment from current assets into consideration?

I know we may not since these are not coming from the daily operation of a company. And the objective of the DCF model is to figure out what the company gains and spends from operating activities.

Can somebody justify my understanding and explain it in a simple word please?

Thanks!

Reply by a searcher
from Harvard University in Westchester County, NY, USA

It depends on how much granularity is available and desired in the model. Sometimes the change in NWC can be calculated purely as a percent of revenue, or as the percent of change in revenue, or if the data available includes how cash and current assets are forecasted, you would simply project how the independent variables change and take the change in NWC that occurs from the forecasted variables. I would check Damodaran or McKinsey valuation and see what they say to be safe, though.

Reply by a searcher
from University of Texas at Austin in Dallas, TX, USA

If by short term investment you mean "cash and cash equivalents", then I would not include it. Your change in NWC is part of your walk down to free cash flow, so it is explaining the change in cash.

+1 more reply.

Join the discussion