Financial Model - Impact of Accounts Receivable on FCF

CFA General
#1

I have built a financial model that is fully linked and balances and everything responds the way I would expect when I make changes, except for one thing. When I increase revenues in the last year of my projection, it actually leads to a lower equity price. Was hoping for some tips if anyone has experienced this before. One thing I have noticed is that when I increase the final year revenue projection is that the Accounts Receivables increases, which makes sense (i have projected A/R based on the average of their past 5 year Accounts Receivable Days), however its resulting in a lower CFO and FCF resulting in a lower equity price. I also notice, but not the same extent, that prepaid expenses are having a similar effect.

Would appreciate any advice!

Thanks

#2

If is model based on following cash conversion:

Sales generated = (AR increase - AR collected ) = Cash increase, you might skip the mid process in parentheses and directly link Increase in Sales with cash collected. Otherwise your model is based on valid accounting assumption and this is increase in AR balance at sales on credit (if still not collected) means CFO decrease at particular end of period. Seems you mismatched accounting accrual process with fitted equity price.

If more cash at the end of period in your model simply means higher equity price and vice versa, skip changes in AR balance and assume all receivables are immediately collected. If, for particular reason, such estimate is not appropriate, then model is based on valid accounting basis.

#3

Are you using the Gordon growth model for your terminal value? And if so is the growth rate below the growth rate in your final projected year? If so that might be the fix, have the last year equal to the terminal growth rate.

Companies generally have to reinvest more cash to grow faster, so if your growing at 6% (for example) you will need double the incremental working capital as if you grew at 3%. If you just applied the Gordon growth to the last year you would be assuming double the reinvestment that you need, so its not too surprising that your value goes down.