Reading: Extensions and FAQ
A solid financial plan is the basis of every valuation exercise and every significant management decision. The financial plan allows us to identify the firm's capital needs as well as its ability to generate cash. It also unveils the various sources and uses of funds. This section shows how to set up a financial plan.
1. Extensions and FAQ
1.4. Share Repurchases and Treasury Shares
Many (listed) firms repurchase shares instead of paying dividends because share repurchases often constitute a more tax-favorable form of distribution. For valuation purposes, the different forms of payout are not central, as we are typically interested in the free cash flow, which is unaffected by financing activities.
Still, it may be useful to know how to reflect share repurchases in our financial planning framework. Like dividend payments, share repurchases are a cash flow from equity financing. The main difference is that they do not constitute a use of retained earnings. Hence, unlike dividends, share repurchases do not reduce the balance sheet item Retained earnings. Instead, they are recorded in a separate item Treasury shares, which is listed in the firm's equity and takes on the negative value of the repurchased (and not cancelled) shares. Higher share repurchases increase the amount of treasury shares and therefore reduce the book value of equity.