What is the best business valuation method?
It is widely agreed by business valuation experts that the Discounted Cash Flow (DCF) methodology is the most precise way of valuing a business. It is based on the generally accepted theory that the value of a business depends on its future net cash flows, discounted to their present value at an appropriate discount rate (often called the weighted average cost of capital). This discount rate represents an opportunity cost of capital reflecting the expected rate of return which investors can obtain from investments having equivalent risks.
A terminal value for the asset or business is calculated at the end of the future cash flow period and this is also discounted to its present value using the appropriate discount rate. DCF valuations are particularly applicable to businesses with limited lives, experiencing growth, that are in a start-up phase, or experience irregular cash flows. However, applying a DCF valuation relies entirely upon having accurate cash flow forecasts that set out not only how much cash will be received in the future, but when it will be received, and how much it will cost to produce the cash flows. It is rare for a small to medium business to possess this level of cash flow forecasting, and thus the capitalisation of future maintainable earnings methodology is often utilised instead.