DCF (Discounted Cash Flow) values a company by forecasting its future free cash flows and converting them to present dollars using a discount rate that reflects risk and time value of money.

How it works

Analysts build a multi-year model: revenue growth, margins, capital expenditure, working capital, and taxes yield unlevered free cash flow each period. Those flows are discounted back with a rate often derived from weighted average cost of capital (WACC).

After the explicit forecast, a terminal value captures cash flows beyond the model — commonly via a perpetual growth rate or exit multiple on terminal EBITDA. Terminal value often dominates the result, so small assumption changes swing outcomes sharply.

Private equity and strategic acquirers use DCF for businesses with stable cash generation. Early venture startups rarely get priced via DCF because negative cash flows and binary outcomes break the method — comparables and venture rounds set marks instead.

Sensitivity tables show how value moves if growth or margins shift — a honesty check on optimism in management plans.

Why it matters

• Founders: In profitable-company sales or PE roll-ups, acquirers will DCF your plan. Overstated margin expansion gets challenged in diligence.
• Investors: Later-stage and buyout teams blend DCF with trading comps and precedent transactions. Understanding their discount rate explains bid gaps.

Common mistake

Treating a single DCF output as precise truth. The method is only as credible as assumptions — especially terminal growth — and early startups should not pretend DCF sets seed valuations.

Related ideas

See also entry multiple, WACC, terminal value, and comparables analysis.