400  Valuation by Parts
supplied materials, one unit’s revenues are no longer another unit’s costs, and 
some earnings and inventory now must be eliminated in the consolidation as 
well. ConsumerCo’s consolidated financials eliminate $2 million in earnings 
and $50 million in inventory (see the Eliminations I column of Exhibit 19.6).4 
As in most situations, the earnings impact is small because it is driven by the 
change in inventory, not the final inventory. Note that in any case, the elimi-
nations cannot affect ConsumerCo’s aggregate free cash flow and enterprise 
DCF valuation, because consolidation adjustments to inventory always offset 
the changes in NOPAT.
When you build and forecast the financial statements for the business 
units, treat each unit as if it were a stand-alone company, using total sales (ex-
ternal plus internal). Otherwise, margins and comparisons over time and with 
peers will be distorted. Prepare separate projections of the consolidation elimi-
nations, similar to the corporate center. The growth rate of intercompany sales 
can be estimated from the details of how and why these items arise. It is sim-
plest to assume that the eliminations grow at the same rate as the entire group 
or as the receiving businesses. Remember, however, that the eliminations are 
used only to reconcile business unit forecasts to the consolidated-enterprise 
forecasts. They do not affect the value of the company or the individual busi-
ness units.
Intercompany Financial Receivables and Payables  Multibusiness compa-
nies typically manage cash and debt centrally for all business units, which 
can lead to intercompany receivables from, and payables to, the corporate 
parent. Sometimes these intercompany accounts are driven by tax consider-
ations. For example, one business unit might lend directly to another unit 
so that funds don’t flow through the parent company, which could trigger 
additional taxes. Sometimes the accounts have no economic purpose but are 
simply an artifact of the company’s accounting system. Regardless of their 
purpose, intercompany receivables and payables should not be treated as part 
of operating working capital but as intercompany equity in the calculation of 
invested capital.
The Eliminations II column of Exhibit 19.6 shows how this occurs for Con-
sumerCo. The parent company has $5,097 million of equity investments in its 
subsidiaries, of which $700 million is in the private-label unit, for example, as 
reflected in the equity of the subsidiary accounts. This accounting treatment 
is for internal reports only; since ConsumerCo Corporation owns the private-
label business in its entirety, its financial statements are consolidated for ex-
ternal reports, eliminating the $700 million of equity investment. The same 
holds for the other businesses shown. This leads to the elimination of $5,021 
4 There is no impact on cash taxes or free cash flow from the accounting consolidation. We abstract from 
any impact of tax consolidation (fiscal grouping) in this example.