Why the Discounted Cash Flow (DCF) method is usually the most representative way to understand the value of a company

DCF method: a key and accurate approach to valuing companies

When we talk about business valuation —understanding the economic value of a company— there are many possible methods, depending on the characteristics of the business and the data available. Among them, the DCF method —Discounted Cash Flow— is the most well-known and widely used in the corporate world.

People often focus on present value. For example, most would rather receive €1,000 today than €2,000 a year from now due to future uncertainty. Applied to businesses, many think their company is highly valuable because it generates strong revenues or because they’ve invested years of effort.

But to know if a company is truly valuable, you need to look at its ability to generate income in the future — in other words, its potential. A company that’s profitable today but has no promising future might not be worth much. To use a football analogy: a striker scoring a lot this season but nearing retirement is worth less than a younger player with a long career ahead. That’s why Lamine Yamal is worth more than Lewandowski, despite the latter’s current performance.

Back to the DCF method — it allows us to determine a company’s value based on its future cash flow generation. In short: the value of a company is equal to the present value of its future cash flows, discounted by a rate that reflects risk and cost of capital.

Advantages of the DCF method

• It focuses on the real ability of the company to generate value — the money available to investors after covering all investments and expenses.
• Allows a small-revenue company to be highly valuable if it consistently generates cash.
• It’s a forward-looking method that visualises growth potential under the current strategy.
• Enables multiple future scenarios, offering a broader vision of possible outcomes.
• Useful in negotiations — a strong and well-argued future outlook can justify the valuation to potential buyers.

Limitations of the DCF method

• It’s hard to predict the future accurately, and small assumptions can greatly affect the result.
• Small changes in the discount rate can significantly alter the valuation.
• More suitable for established companies with stable results and a clear strategy.
• It’s relatively complex, involving variables such as:

1. WACC (Weighted Average Cost of Capital): the blended cost of equity and debt financing. It’s used to discount future cash flows. The higher the WACC, the higher the perceived risk.
2. Free Cash Flow: the cash a company generates after covering operational costs, CAPEX and working capital. It represents the money available to investors.
3. Perpetual growth rate: the assumed rate at which cash flows will grow after the forecast period. Used to calculate terminal value.
4. CAPEX: investments in fixed assets required to maintain or grow production capacity.
5. Working Capital: funds needed to support daily operations (inventory, receivables, payables).

Who uses the DCF method?

From large corporations to SMEs, many companies use the DCF method to assess M&A transactions. It’s also used by VCs, private equity funds, financial analysts and investment banks.

Firms like ST Strategy use this method regularly in M&A transactions and capital raises, even if it’s not always the sole reference.

Conclusion

There may be faster or simpler methods than DCF, but none are as effective at valuing a company’s future cash flow generation.

The method is also independent of market benchmarks, focusing solely on the company itself. It accounts for the time value of money — cash today is worth more than tomorrow’s.

For all these reasons, the DCF method remains one of the most widely used approaches in M&A valuations.

Now that you understand how DCF works, if someone asks, “How much is your company worth?”, the best answer might be: “It depends on how much it can generate in the future.”