What Is Discounted Cash Flow (DCF) and How Does It Value a Business?

At Flux Valuations, we employ multiple valuation methods; however, Discounted Cash Flow (DCF) remains a foundational one, particularly for businesses with stable, predictable earnings. This article breaks down DCF in plain English: what it is, how it works, and when it makes sense to use.

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What Is DCF, in Simple Terms?

DCF stands for Discounted Cash Flow. The idea is this:

Your business is worth the cash it can generate in the future, adjusted for the fact that money in the future is worth less than money today.

Instead of relying on what similar businesses sold for (like with market multiples), DCF looks at your actual financials and forecasts. It tries to answer the question: What is the value today of all the money this business will earn tomorrow?

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Why Time Value of Money Matters

A dollar today is worth more than a dollar five years from now. Why?

You could invest that dollar today and earn a return. There’s also risk involved, as future cash flows might not materialize.

DCF accounts for this by “discounting” future cash flows using a discount rate (usually based on risk and industry standards). The higher the risk, the higher the discount, and the lower the valuation.

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The Two-Stage Approach

Most DCF valuations happen in two parts:

Forecast Period (5–10 years): We project revenue, costs, and investments to estimate free cash flow each year.

Terminal Value: Instead of forecasting forever, we estimate the value of cash flows after the forecast period using a simplified method (often called the Gordon Growth or Exit Multiple method).

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Free Cash Flow (FCF): The Heart of DCF

Free Cash Flow is what’s left after a business pays its bills and reinvests to keep running and growing. It’s a more reliable measure of real profitability than accounting numbers, like net income.

There are two types of free cash flow:

Unlevered (FCFF): Before debt payments, used to value the entire business (Enterprise Value).

Levered (FCFE): After debt payments, used to value only the equity (what shareholders own).

Most valuations, including ours at Flux, use Unlevered Free Cash Flow (FCFF) and apply a Weighted Average Cost of Capital (WACC) as the discount rate.

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What’s the WACC?

The WACC is your business’s blended cost of capital, the average rate you’re expected to pay investors (both lenders and shareholders). It reflects:

Cost of Equity: What investors expect to earn for taking risk (estimated using the CAPM model).

Cost of Debt: The interest you pay on loans, adjusted for tax savings.

Why it matters: This rate is used to discount your future cash flows.

Higher WACC = more risk = lower valuation.

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Terminal Value: Estimating the Long-Term Future

At the end of your forecast period (say, Year 10), we estimate the remaining value of the business. There are two main ways:

Gordon Growth Model: Assumes your cash flow grows steadily forever.

Exit Multiple: Assumes your business could be sold for a multiple of EBITDA, based on what similar businesses sell for.

Both are valid. We often use both and cross-check them to avoid unrealistic assumptions.

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What DCF Gets Right (and Wrong)

Strengths:

• Grounded in your actual financial performance, not just market trends
• Very customizable, allows us to model many different scenarios
• Especially useful for profitable, steady businesses with a clear growth plan

Weaknesses:

• Sensitive to assumptions. Small errors in growth rate or discount rate can have a big impact
• Not ideal for very early-stage businesses or those with unpredictable cash flow
• Often relies heavily on Terminal Value, which can skew results if not done carefully

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A good DCF model doesn’t try to give one magic number; it gives a valuation range. At Flux, we run sensitivity tests (changing growth rates, discount rates, etc.) to show how your business value shifts under different assumptions.

That’s why we say: DCF isn’t just about finding the “right” number. It’s about creating a well-reasoned, financially sound story of what your business could be worth.

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At Flux Valuations, we don’t just plug numbers into a formula. We help you build a defensible, data-backed picture of what your business is worth. Whether you’re selling, planning an internal buyout, or just need clarity, we’ll guide you through every step.

See pricing and more details here.