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M&A Vocabulary – Explained by the experts: Cash Free & Debt Free


In this ongoing series, a number of different M&A experts from the global offices of Rödl & Partner each present an important term from the English specialist language of the mergers and acquisitions world, combined with some comments on how it is used. We are not attempting to provide expert legal precision, review linguistic nuances or present an exhaustive definition, but rather to give a basic understanding or refresher of a term and some useful tips from our consultancy practice.


The concept of Cash Free & Debt Free (or CFDF) is simple to define and easy to apply, making it a purchase price mechanism that is used worldwide in the negotiation of company transactions. But, what exactly does it mean to use the CFDF mechanism as part of a transaction?

Basically, it means that until the closing date (i.e. the last date on which the target company is still owned by the vendor) the vendor is theoretically entitled to retain all cash and to pay off all debts. This is not usually done in practice (at least not for a share deal), instead all the cash and debt remaining on the Balance Sheet at the closing date is added/deducted as appropriate from the Enterprise Value (i.e. the total value of the company, being the market value of the equity plus the value of debt capital) in order to determine the final Purchase Price.

In practice the Purchase Price is normally composed of: (i) the Enterprise Value (EV) defined in the share purchase agreement (“SPA”) which is the result of the Company’s valuation, as well as (ii) the amount of cash & cash equivalents minus (iii) debt and debt-like items plus/minus (iv) any other purchase price adjustments agreed between the parties (e.g. differences in the level of net working capital between the average level defined in the SPA and the actual value on the balance sheet at the closing date).

We will briefly explain below items (i) to (iii) mentioned above, to clarify the way in which the CFDF mechanism works and its importance in practice.


Enterprise value (EV)

The Enterprise Value refers to the market value of all sources of a company’s capital (i.e. the market value of debt capital, common equity and preference equity, minus cash and cash equivalents). There are several techniques for determining a company’s enterprise value. In M&A practice, discounted cash flow methods and approaches using multiples are the most widely applied methodologies. In terms of multiples valuations, EBITDA- and EBIT-multiples are by far the most common multiples used.

EBITDA and EBIT are profitability indicators unaffected by the financing structure of a company. They are thus suitable for determining the Enterprise Value of a company.
As part of a share deal acquisition, shares are acquired in the target company. The value of these shares is represented by the “Equity Value” (market value of the equity capital). To determine the equity value it is necessary to exclude the effect of net debt (i.e. (ii) cash and cash equivalents – (iii) debt and debt-like items).


Cash and cash equivalents

The financing structure will vary for each specific M&A deal and will be set up individually. The definition of cash and cash equivalents is generally the same, however. The most conservative definition would consider only cash in bank accounts (i.e. available on demand), although sometimes there are other items in the Balance Sheet that are classified as cash equivalents. As part of a due diligence, they must be analysed, quantified and adjusted if necessary. These include:


  • Restricted cash: Restricted cash - in contrast to unrestricted cash which is freely available for a company to spend or invest - refers to cash that is held for a specific purpose and therefore is not available to the company for immediate or general business activities. Most of these cases relate to bank deposits offered as collateral (e.g. legal deposits or guarantees for bank loans and other forms of financing). In theory, restricted cash should only be considered as a cash equivalent if there is a relative liability which is included as a debt-like item. Nevertheless, it is crucial to understand and evaluate the specific features of each individual case.
  • Petty cash: Mainly in emerging countries, where companies’ internal controls are not always very sophisticated, this account is regularly used to register reconciliation differences. In this case, the petty cash should not be considered as a cash equivalent.
  • Other examples: Credit card receivables and payments in transit; bank reconciliations; escrow accounts; loans to third parties, etc.


Debt and debt-like items

The definition of debt and debt-like items for an M&A deal is generally broader than just bank loans and financing. For instance, an item can be considered as a debt or debt-like item regardless of whether it is shown as a liability on the Company’s balance sheet. Some examples of debt and debt-like items are:


  • Loans and financing: The most common example are loans taken out with banks or financial institutions.
  • Long term provisions: Long-term provisions are usually discounted, and are therefore not fully reflected in the company value. So, for example, expenses for the creation of future provisions are not included in the multiplier basis used for valuation. Long-term provisions should be considered as a debt-like item (e.g. for pensions, age-related part-time working, employment anniversaries, provisions for lawsuits, or environmental issues).
  • Debt-like items: There are other examples of debt-like items that should be assessed by both parties during the deal, which can have a direct impact on the purchase price (e.g. provisions for income taxes; overdue payments to suppliers; advance payments from customers, loans from third parties, capex backlog, extraordinary liabilities from capex).
  • Materialized and non-materialized exposures: Materialized exposures (e.g. lawsuits against the company) together with imminent exposures (e.g. non-compliant procedures that could result in a materialized exposure in the future) are also treated as debt-like items. The likelihood of their occurrence and the total amount should be evaluated by legal advisers.


Please see below a presentation of a brief summary of the practical application of some of the headings presented in this article:


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Philipp Klose-Morero

Managing Partner South America

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Rafael Silveira Martins

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