The Most Common Business Valuation Methods

Following part one and part two of our series on the most common business valuation methods, it’s time for part three. This time, we’ll focus on the discounted cash flow (DCF) method and explain why, in most cases, it’s worth leaving valuations to professionals who deal with them on a daily basis.

Valuing a Business Using the Discounted Cash Flow (DCF) Method

DCF (Discounted Cash Flow) is one of the most advanced methods for valuing a company—and one that even experienced professionals sometimes struggle with. It’s based on forecasting the future cash flows a business is expected to generate and discounting them to their present value.

Key DCF Element: Financial Projections

Accurate financial forecasts are the foundation of a reliable DCF valuation. These forecasts typically cover a 5- to 10-year period and include the income statement, balance sheet, and cash flow statement. Success here depends on a deep understanding of the business model and its financial dynamics, as well as proficiency in financial modeling. You also need to factor in capital expenditures (CAPEX), shifts in revenue structure, inflation, interest rates, and any company-specific characteristics.

Key DCF Element: Cash Flows

Based on these projections, you calculate Free Cash Flows (FCF), which reflect the company’s ability to generate profits after accounting for investments in working capital, planned capital expenditures, tax structure, and depreciation. These cash flows are then summed and discounted to present value.

One of the most sensitive steps in this process is determining the right discount rate, typically the Weighted Average Cost of Capital (WACC). WACC reflects the blended cost of the capital the company uses, both debt and equity, and includes company-specific risk factors. Calculating WACC isn’t trivial—it requires inputs such as the risk-free rate, beta, market risk premium, and credit spread.

Even small errors in estimating these components can significantly distort the final valuation, as the DCF model is highly sensitive to the discount rate used.

Key DCF Element: Terminal Value

Once the discounted free cash flows are calculated, the next step is to estimate the Terminal Value (TV), which also gets discounted to present value. Terminal Value, based on the concept of perpetuity from finance theory, might seem abstract—but in practice, it represents the value of all cash flows beyond the projection period. In standard models, we assume the business will continue operating and generating free cash flows after the forecast horizon.

Key DCF Element: Net Debt

The final step in the DCF valuation process is deducting net debt—a relatively straightforward task compared to the rest of the methodology.

To sum up, the DCF method is often considered the most precise valuation approach because it incorporates a company’s unique risk profile, investment plans, and growth potential. However, it’s also the most complex and highly sensitive to input assumptions, requiring both detailed forecasts and careful calculation of the discount rate.

DIY or Professional Valuation?

The valuation methods described in this article series are only a general outline of how to approach company valuation. In real life, every business is different—and the number of factors that influence value is so large that it’s easy to make mistakes that skew the results.

So if you want a reliable and professional valuation of your business, get in touch with us. We’ll guide you through the process and select the most suitable valuation method based on your objectives and growth strategy.

A valuation project is often the starting point for a broader strategic review of your business model. As part of our work, we conduct a deep analysis of key performance indicators (KPIs) and the main drivers of enterprise value.

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