Methods of business valuation: Discounted Cash Flow method

In a company sale or transfer, the value of the company plays a major role. It forms the foundation for sale price negotiations. However, there are various methods for determining the value of a company. We explain the differences and which additional factors influence the sale price. Today we explain the Discounted Cash Flow method to you.

The value of a company can be determined in several ways. Depending on the chosen method, this can also vary considerably. The sales price of the company often does not match the value of the company, as other factors also flow into the negotiation, but the determined value forms the basis for price negotiation. Fundamentally, there are four different methods for evaluation, which we will discuss in more detail in the article series "Methods of Business Valuation": Discounted Cash Flow, Earnings Value, Liquidation, and Multiplicator.

Discounted Cash Flow Method (DCF Method)

The Discounted Cash Flow method is intended to determine the future earnings the buyer of the company can expect. The basis of this method is the expected earnings (Cash Flow), which are discounted to a specific valuation date to obtain the present value of the cash flow. The necessary capitalization rate for discounting (also called discount rate) usually lies between 10 and 20%. There are various, partly very complex methods to derive this discount rate, which can involve considerable effort. To perform the DCF method, a large number of documents from one's own company (income statement, balance sheet, cash flow statement, depreciation schedule, investment plan), competitor data (competitive analyses, strategy, financial situation) as well as market and trend analyses (industry reports, economic forecasts, trend analyses) are required, on the basis of which further documents such as investment tables, a planned income statement, a planned balance sheet & cash flow statement or a planning horizon can be created. Other required parameters for the DCF method are the aforementioned discount rate, tax rate, rent prices, or material costs.

With this method, unrealistically high company values can result, which is why it is almost only suitable for companies that have been showing a continuously growing profit for years. Findea helps you keep your taxes simple and hassle-free.

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