Discounted cash flow
A valuation method that projects future free cash flow and discounts it to present value at a rate reflecting the risk of those cash flows.
Also called: DCF
A DCF builds value from the ground up: forecast free cash flow for a period, estimate a terminal value at the end of it, and discount everything back at a rate that reflects how risky those cash flows are. It is the method finance textbooks lead with, and it is genuinely useful for understanding which assumptions drive value.
In small and lower-middle-market transactions it is rarely the number that sets the price. The inputs it needs — a credible multi-year forecast, a defensible discount rate for a single owner-operated company, a terminal growth assumption — are exactly the inputs that are least reliable at this size. Small changes to the discount rate or terminal growth swing the output enormously, which makes a DCF easy to build to whatever answer you wanted.
Where it does earn its keep is in sensitivity analysis. Running a DCF shows how much of the value depends on the largest customer renewing, or on margins holding through a price increase. That insight is useful even when the actual price ends up being set by a multiple, because it tells you which risks a buyer will focus on.
Where sellers get caught
- Presenting a DCF built on a hockey-stick forecast. It reduces credibility rather than raising the price.
- Using a public-company discount rate for a business with three customers and one salesperson.
- Forgetting capex and working capital growth in the free cash flow build.
Common questions
Will a buyer use a DCF on my business?
Some institutional buyers build one internally, but at this size the negotiation almost always lands on a multiple of adjusted earnings. The DCF informs their internal return model rather than the offer they put in front of you.
Is a DCF worth commissioning before a sale?
Usually not as a pricing exercise. The same money spent on cleaning up financial records or reducing owner dependence tends to move the actual price further.
Related terms
EBITDA multiple
The factor applied to adjusted earnings to produce enterprise value, set mainly by size, industry, growth, and how dependent the business is on its owner.
Enterprise value
The value of the business itself, independent of how it is financed — and not the amount the seller receives.
EBITDA
Operating profit before financing, tax, and non-cash charges, used as the earnings base most buyers of lower-middle-market companies price against.
Quality of earnings
An independent accounting analysis that tests whether reported earnings are real, recurring, and sustainable.
Guides that use this term
Where discounted cash flow comes up in a real sale, and what it changes.
Last reviewed 2026-08-25. General information for business owners, not legal, tax, or financial advice — terms, thresholds, and tax treatment vary by jurisdiction and by deal.