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What does a DCF model tell you?
A DCF model, short for discounted cash flow model, values a business on the cash it will produce. You forecast the free cash flow for each year, discount it back to today at a rate that reflects the risk of actually receiving it, and add a terminal value for the years beyond the forecast. The total is enterprise value: what the whole business is worth before you subtract its debt.
Picture a café group with three sites in Brisbane. A buyer is not really paying for last year’s profit; they are paying for the cash the sites will produce from here. A DCF makes that explicit. Rent reviews, a new site’s ramp-up, wages and the refit due in year four all flow through to one number, and you can see which assumption moves it most.
What goes into a discounted cash flow model?
Every business valuation model built on a DCF has the same five parts. The skill is in getting each one right for the business in front of you.
- Free cash flow: operating profit after tax, plus depreciation, less capital spending and the extra cash tied up in working capital. It should come from a full forecast of the profit and loss, balance sheet and cash flow.
- The discount rate (WACC): the cost of equity and the after-tax cost of debt, weighted by a target mix of the two. Listed peers supply a beta; a private business without comparable peers usually builds the rate up from premiums.
- Terminal value: everything after the forecast, on perpetual growth or an exit multiple. It is often most of the answer, so it deserves the most scrutiny.
- The bridge to equity: enterprise value less net debt, lease liabilities and other debt-like items gives the value of the shares.
- Timing: a valuation date, with each period’s cash discounted from the middle of the period, because cash arrives through the year rather than on its last day.
Which mistakes move a DCF valuation?
Most DCF errors are not maths errors. They are assumptions that compound quietly, then get multiplied into perpetuity.
- Terminal growth at or near the discount rate. The formula blows up. Long-run growth belongs near inflation plus real economic growth.
- An unusual final year. A big capex year, a working-capital swing or a seasonal last quarter gets repeated forever.
- Mismatched cash flows and rates. Cash flow to the firm goes with WACC; cash flow to equity goes with the cost of equity.
- Risk counted twice. Cut the forecast or add a premium to the rate, not both.
- A private company left unadjusted. Owners’ salaries, related-party rent and one-off costs distort the earnings a buyer would actually get.
- A circular rate. Weighting WACC by the model’s own equity value lets the answer set the rate. Use a target gearing instead.
How do investors read a valuation?
Buyers and investors rarely take a DCF at face value. They go straight to the terminal value: how much of the total it is, and the growth rate or multiple behind it. Then they flex the discount rate and growth, compare the implied multiples with what similar businesses trade or sell for, and trace the big inputs back to a source.
So no single method should stand alone. You choose from seven: discounted cash flow, trading multiples (EV/EBITDA), price to earnings, net asset value, dividend discount, sum of the parts and precedent transactions. The model sets the ones you pick side by side, shows the range by method and concludes on a weighted average. The right mix depends on the business:
- A dental practice for sale: precedent sales of similar practices, applied to earnings with the owner’s salary set at market.
- A 40-room hotel: net asset value from the latest valuation, beside a DCF of its trading cash flows.
- A solar farm on a 25-year contract: a DCF that runs to the end of the asset’s life, with no perpetual growth at all.
- A SaaS start-up before profit: scenarios matter more than one DCF, because most of the value sits years out.
Why not just download a DCF template?
A free DCF template, or any valuation model Excel template, gives you the discounting and leaves the hard part to you: the forecast. Its free cash flow row is usually typed in, so nothing ties it to a balance sheet, and a missed capex line flows straight into the value.
We build the whole thing for your business, free. The DCF sits on an integrated three-statement forecast, with inputs in blue and the source of each one noted. The terminal value comes from a full financial year, the discount rate never depends on the value it produces, and the model shows the multiple your growth rate implies, or the growth your exit multiple implies. A Checks sheet proves the balance sheet balances in every period, and our team reviews every model before it is sent.
Preview every sheet before you download the Excel file. A DCF is a calculation, not advice: check the assumptions and get professional advice before you rely on the number.