Discounted cash flow (DCF)

Valuing a business by projecting its future cash flows and discounting them back to what they are worth today.

In more detail

A DCF forecasts free cash flow over several years, estimates a terminal value for everything after that, and discounts the whole stream at a rate reflecting the risk of not receiving it. It is the most theoretically rigorous approach and it is rarely the primary method for a small business, for one reason: it is only as good as the projection, and nobody can verify a projection. Change the growth assumption by two points or the discount rate by one and the answer moves enormously. Buyers know this, which is why a seller who arrives with a DCF showing a high number usually finds it discounted rather than debated. Where it earns its place is with predictable, contracted cash flows, or as a cross-check on a value derived from comparable sales.

For example

Five years of projected cash flow plus a terminal value, discounted at 20%, might value a business at $4.2M. Move the discount rate to 25% and the same projection gives roughly $3.4M.

If you are selling

Useful for your own planning. Do not expect a buyer to price off your forecast, because they are buying results, not intentions.

If you are buying

Worth building as a sanity check on the multiple, especially where revenue is contracted. Be honest about how sensitive the answer is to your own assumptions.

Related terms

Wondering what your business is actually worth?

An Estimate of Value is prepared by an analyst, not a calculator, and gives you a number you can plan around.

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