Discounted Cash Flow (DCF)

Published On August 17, 2026

What is Discounted Cash Flow?
How Does DCF Valuation Work?
DCF Formula
Key Components of DCF
Related Valuation Terms

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What is Discounted Cash Flow?

Discounted Cash Flow is an income-based valuation approach that estimates the value of a business by calculating the present value of its expected future cash flows.

Money received in the future is generally worth less than the same amount received today because of factors such as the time value of money and investment risk.

DCF therefore discounts future cash flows to arrive at their present value.

DCF is commonly used in:

Business valuation
Startup and corporate valuation
Mergers and acquisitions

Investment analysis
Financial reporting
Strategic decision-making

How Does DCF Valuation Work?

A DCF valuation generally involves the following steps:

Step 1: Forecast Future Cash Flows

The first step is to estimate the company's future cash flows over a defined forecast period.

Step 2: Determine the Discount Rate

An appropriate discount rate is selected to reflect the time value of money and the risk associated with the expected cash flows.

Step 3: Calculate Terminal Value

A terminal value is estimated to represent the value of the business beyond the explicit forecast period.

Step 4: Discount Future Cash Flows

The projected cash flows and terminal value are discounted back to their present value.

Step 5: Determine Enterprise Value

The present value of the forecast cash flows and terminal value is combined to estimate the business's enterprise value.

DCF Formula

A simplified DCF formula can be represented as:
Enterprise Value = Present Value of Forecast Cash Flows + Present Value of Terminal Value

The present value of an individual future cash flow can be calculated using:
PV = CF / (1 + r)ⁿ

Where:
PV = Present Value
CF = Future Cash Flow
r = Discount Rate
n = Number of periods

The actual valuation model may involve additional adjustments depending on the purpose of the valuation and the nature of the business.

Key Components of DCF

Component	Description
Free Cash Flow	Free Cash Flow represents the cash generated by a business that is available after considering the cash required for operating activities and capital investments.
Forecast Period	The forecast period is the period for which future cash flows are explicitly projected.
Discount Rate	The discount rate reflects the required return associated with the investment and the risks relating to the projected cash flows.