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In the same context like growth rate of sales but better is to use turnover items of working capital or turnover working capital as a whole
I dont quite understand, if you increase the turnover and working capital with the same growth rate, the absolute value will be different. Let say for example, turnover 100 and working capital also is 100 and growth rate is 10%. Next year turnover is 110 and the same goes to working capital. What if the 10 increase in turnover is derived from cash transaction? The 10 from working capital might be derived from elsewhere, maybe from a/c receivable, payable and inventory. So again, what is the preferable growth rate for working capital when calculating DCF?
I mention turnover in the meaning of how many days you need to transform a item into cash e.g. Turnover time of inventories is about 60 so that you need to wait 60 days until one piece of inventories is sold. When you plan work capital you will aim every item separately e.g. Turnover time of inventories is for 2011 60 days 2012 65 days and finally you work item out according to this formula: turnover time of item * sales / 365 equals item for future year. Preferable growth of working capital is prefed for residual period (5, 10 or 15 years later, for stabilised business) and it could be somewhere between expecting inflation and growth of GDP
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Working capital should be assumed as a % of sales ...so if sales grow so will working capital needs .. to determine the % to be used ... use historical average post confirming with industry average ... if company has had negative change in WC in the past... use closer to industry average .. if industry average is currenty ngative set chan
ge in WC to Zero..
I agreed with you Pavel, but for residual period, is that the practise to use GDP growth rate, i know is time consuming to forecast every items on financial statements to get accurate working capital for residual period (5, 10, 15 years), but wouldn't it be a fundamental errors (accounting) in terms of cash flows for those period?
I am not sure what you mean. This approach is common in european condition and I don't see any problem with this technique. There will be the deviation from future reality but it is not against DCF approach.