Business Valuation – Discounted Cash Flow #small #business #finance
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Business Valuation – Discounted Cash Flow
Business valuation is typically based on three major methods: the income approach, the asset 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.
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The estimated Net Present Value (NPV) of your business is NPV_VALUE.
Your cash flow was estimated in two parts. First from your cash flow statement, and secondly from projecting future cash flows assuming a growth of EXPECTED_ANNUAL_GROWTH. We first calculated your estimated cash flow for year one from your inputs. An additional PROJECT_ADDITIONAL_YEARS years of cash flows were calculated assuming a EXPECTED_ANNUAL_GROWTH annual growth (for a total of PROJECT_YEARS). Each year’s estimated cash flow was then discounted by WEIGHTED_AVERAGE_COST_OF_CAPITAL (your weighted average cost of capital) for the number of years until the cash flow would be realized. The sum of all of your future discounted cash flows is the net present value of your business. **GRAPH**
What else can I do to increase my valuation?
- Increase your operating profits:
You can directly impact your valuation by becoming more profitable. Increased efficiency and lower operating expenses can have a dramatic impact on your business’ valuation. Even relatively small increases in profitability can have a dramatic impact on your valuation.
By reducing your inventory and accounts receivable, you can decrease the amount of capital that is tied up in your business. The net change directly affects your valuation.
Very much like reducing your inventory, reducing your tax burden can directly impact the value of your business. A business that creates effective tax shields can be worth substantially more than one that doesn’t consider this important variable.
Target your capital expenditures to projects that increase your growth rate, or increase your profitability. While capital expenditures reduce your near-term cash flow, effective investment in your business can have a positive impact in your valuation.
Your cash flow statement:
Business Valuation – Discounted Cash Flow Definitions
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).
Expected annual growth This is the rate you expect your business to grow. This rate is only used on years 2 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.
Years of cash flow to include This is the number of years that the projection will include in the value of your business. For example, if you include 100 years (the maximum) we calculate the present value of all future cash flows generated for the next 100 years into your business’ value. Entering a high number would assume that the business would continue with the current projections for that entire length of time. You may wish to reduce this projected period if you have a known end date for the business cash flows, or to make a more conservative estimate of the value.
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 buildings 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 had an increase in accounts payable, your cash flow goes up. If you 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 a 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.
Other net change Enter any other net change in other assets or liabilities that impacted your cash flow for the period.
Capital expenditures This is the amount you spent on capital equipment and buildings 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.
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KJE Computer Solutions, LLC’s information and interactive calculators are made available to you as self-help tools for your independent use and are not intended to provide investment advice. We cannot and do not guarantee their applicability or accuracy in regards to your individual circumstances. All examples are hypothetical and are for illustrative purposes. We encourage you to seek personalized advice from qualified professionals regarding all personal finance issues. More Information