What is Discounted cash flow (DCF) analysis?


In the discounted cash flow approach, an analyst will forecast all future free cash flow for a business and discount it back to the present value using a discount rate (such as the weighted average cost of capital). DCF valuation is a very detailed form of valuation and requires access to significant amounts of company information. It is also the most heavily relied on approach, as it incorporates all aspects of a business and is, therefore, considered the most accurate and complete measure.

A DCF model is a specific type of financial modeling tool used to value a business. DCF stands for Discounted Cash Flow, so a DCF model is simply a forecast of a company’s unlevered free cash flow discounted back to today’s value, which is called the Net Present Value (NPV).

Even though the concept is simple, there is quite a bit of technical background knowledge required for each of the components mentioned above, so let’s break each of them down in further detail. The basic building block of a DCF model is the 3 statement financial model.

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