Business Valuation - Discounted Cash Flow

Business valuation is typically based on three major methods: the income approach, the cost approach and the market (comparable sales) approach. Among the income approaches is the discounted cash flow methodology calculating the net present value ("NPV") of future cash flows for an enterprise. As an alternative to the more abbreviated income capitalization approach, this methodology is more relevant where future operating conditions and cash flows are variable – or not projected to be materially consistent with current performance levels.

Definitions

Expected annual growth This is the rate you expect your business to grow. This rate is only used on years 5 and above to estimate your future cash flow. Weighted average cost of capital (WACC) This is the cost of capital, or the interest rate, your investors require to put money into your business. Unless you are a Fortune 500 company with excellent business credit scores, this rate should be at least 12% to 25%. For small businesses that rate can be much higher. NPV Value of your business This is the value of all of your future cash flows discounted in today's dollars at your Weighted Average Cost of Capital (WACC). Operating profit This is your total profit before interest and taxes. This is often called Earnings Before Interest and Taxes or EBIT. Interest expense Total interest expense for the year. Interest income Total interest income for the year. Income taxes Total income taxes paid for the year. Depreciation and amortization If you had any depreciation on equipment or land enter those amounts here. They are added back into your cash flow. Change in accounts payable If you had a net change in your accounts payable, enter the change here. If you have an increase in accounts payable, your cash flow goes up. If you have had a decrease in your accounts payable, your cash flow is reduced. Change in inventory If you had a net change in your inventory, enter that amount here. If you are holding more inventory your cash flow is decreased. Change in accounts receivable If you had net change in your accounts receivable, enter that amount here. Reducing your accounts receivable by collecting money owed more quickly can increase your cash flow and your valuation. Changes in operating assets & liabilities Enter any net change in operating assets and liabilities. Other net change Enter any other net change that impacted your cash flow for the period. Capital expenditures This is the amount you spent on capital equipment and land that you were not able to expense for the period. If you were able to expense the expenditure it is already accounted for in your EBIT. Additional investment income Enter any other investment that increased or (decreased) your cash flow for the period.