Article Summary: Should DCF Valuation Just Go Away? | Axial

I have summarized the key points of the article below.  If you would like to read the entire article, click on the link at the bottom of my summary - Eric Gall

Suzanne Robitaille | August 16, 2017

Sellers of start-ups sometimes come to market at 100x revenue.  Mature businesses at double-digit multiples.  These numbers are not realistic.

Buyers are rational. They will use a multitude of valuation methods to determine the value.  Sellers should use these same methods to determine the value of their business.

Discounted cash flow, or DCF, is one popular method. DCF is equal to the sum of your future cash flows discounted to account for the time value of money.

Falling Out of Favor

DCF is seen as a reliable way to measure the true value of all aspects of a business without having to factor in short-term influences, like taxes. Sellers with high-growth companies appreciate this because it shows strong potential future cash flows, aiding in their asking price.

Many finance experts say DCF is not realistic because it’s impossible to estimate future cash flows beyond the first couple of years. 
DCF is losing favor as a valuation tool among buyers for three reasons:

1. DCF uses one parameter, the discount rate, to manage the value of money over time and uncertainty in cash flows.
2. DCF over-relies on the company’s terminal value which assumes a company will generate free cash flows forever. Terminal value can comprise 50% to 75% of the value in a DCF analysis. Companies do not last forever.
3. Finally, the discount rate is a static and doesn’t account for a changing, global world in which interest rates, risk premiums, and risk-free rates are constantly in motion.

What’s Next for DCF?

For sellers, DCF still has life; use it as follows:  

• DCF is less an analytical device and more a sales tool, backing up a recommendation to buy.
• Use DCF to show buyers how revenues will grow over time and forecast future earnings.
• Be specific. Document how future cash flows will put you in a much stronger position vs.simply relying on industry average multiples and past trends.

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For additional information regarding Florida business sales, acquisitions and valuations, please contact Eric J. Gall, CBI, CM&AP at Eric@EdisonAvenue.com or 239.738.6227. Also, visit our Edison Avenue website at www.EdisonAvenue.com. To search for Florida Businesses for Sale: CLICK HERE