Valuation method

Discounted cash flow

Discounted cash flow builds value from expected future cash, discounted for time and risk. It is the most defensible method in theory and the most sensitive to assumptions in practice.

The mechanics

Free cash flow is projected for a number of years, then a terminal value represents everything after that. Both are discounted at a rate that reflects the cost of capital and the risk of the business.

For a small online business the projection period is usually three to five years. Beyond that, forecasts for a company dependent on advertising platforms and marketplaces are not credible enough to carry weight.

Where the sensitivity sits

In most models the terminal value accounts for more than half of the outcome, sometimes far more. That means two assumptions dominate: the long-term growth rate and the discount rate. A change of one percentage point in either moves the result substantially.

This is why a discounted cash flow calculation should always be presented as a range across scenarios rather than as a single figure. A model that produces one number invites false precision.

Working capital and investment

Cash flow is not profit. Stock that has to be bought before it is sold, payment terms that differ between suppliers and customers, and periodic reinvestment in the platform all consume cash that never appears in the profit line.

For stock-carrying businesses this is often the difference between an attractive model and an unworkable one.

When it is the right tool

Discounted cash flow earns its place where the future is expected to differ from the past for reasons that can be described: a new market being entered, a contract starting, a loss-making line being closed.

For a stable business with a flat record, it usually confirms what a multiple already showed, at considerably more effort.

All valuation methods