Valuation
DCF (Discounted Cash Flow)
A valuation method that estimates what a business is worth today by projecting its future cash flows and discounting them back at a rate reflecting their risk.
The DCF rests on one idea: a business is worth the cash it will generate, adjusted for the time value of money and risk. You project free cash flows over an explicit period (typically 5 years), add a terminal value for everything beyond, and discount it all to the present using a rate — usually a weighted average cost of capital — that reflects how risky those cash flows are. For a small private company, discount rates commonly run 15–25%+, far above public-company rates.
DCF is the 'income approach' in formal valuation work, standing alongside the market approach (valuation multiples from comparable companies and transactions) and the asset approach. Appraisers typically weigh more than one approach rather than trusting a single number.
Its strength is logic; its weakness is sensitivity. Small changes in growth assumptions or the discount rate swing the answer enormously — which is why a DCF is only as credible as the forecast behind it, and why buyer and seller DCFs of the same business rarely agree.
Common pitfalls
- Projecting hockey-stick growth off a couple of good years — appraisers and buyers discount forecasts that break from history
- Letting terminal value carry 80%+ of the total — at that point the 'valuation' is mostly one assumption
- Discounting owner-inflated or owner-subsidized cash flows without normalizing for market-rate compensation
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