Does Enterprise Value Include Working Capital?

I’ve received a few emails asking this question and just realised it’s one of the most popular search terms (that generates traffic to The PrivateEquiteer). The question, as per the search term, sounds a little ambiguous, so let’s reword it…

The question: should working capital affect an enterprise value calculation.
The answer: absolutely.

Your calculation of a firm’s enterprise value must account for working capital because it affects cash flow. And, anything that affects cash flow, affects returns, and anything that affects returns, affects the value of an investment.

For a full run-down of the nuances of WC vs. EV, check out the Working Capital Series. For a quick and dirty understanding, think about changes in working capital. If you must pay creditors before debtors pay you, there is a drain on cash. All else equal (including revenue), this requires a one time injection of cash to support the perpetual lag in payments. But, if revenue grows (and your working capital profile stays the same), you must inject more cash into the business to support the changes in absolute working capital. This continues as long as growth continues and hence affects the long-term investment value.

I realise this seems somewhat rudimentary, but the popularity of the search term suggests otherwise.