Maximizing Value in an M&A Transaction

If you are thinking of selling your business, you might be wondering how much it is worth. One of the most common and reliable methods to value a business is the discounted cash flow (DCF) analysis. In this blog post, I will explain what DCF analysis is, how it works and why it is useful for SMB owners.

What is DCF analysis?

DCF analysis is a way of estimating the present value of a business based on its expected future cash flows. The idea behind DCF analysis is that a business is worth the sum of all its future cash flows discounted to today’s dollars.

To perform a DCF analysis, you need to project the future cash flows of your business for a certain period (usually 5 to 10 years) and then discount them using an appropriate discount rate (also known as the weighted average cost of capital or WACC). The discount rate reflects the risk and opportunity cost of investing in your business compared to other alternatives.

The formula for DCF analysis is:

DCF = CF1 / (1 + r) + CF2 / (1 + r)^2 + ... + CFn / (1 + r)^n

Where:

DCF = discounted cash flow or present value of your business

CF = cash flow in each year

r = discount rate or WACC

n = number of years

How does DCF analysis work?

To illustrate how DCF analysis works, let’s take an example of a hypothetical SMB that sells software products. The SMB has annual revenues of $10 million and annual expenses of $8 million, resulting in an annual free cash flow (FCF) of $2 million. The SMB expects its FCF to grow by 5% per year for the next 10 years. The SMB’s WACC is 10%, which means that it can earn 10% per year by investing in other projects with similar risk and return profiles.

The present value of each year’s FCF is obtained by multiplying it by the discount factor, which is calculated as 1 / (1 + r)^n. For example, the discount factor for year 1 is 0.909, which means that $1 received in one year is worth $0.909 today.

The sum of all the present values gives us the DCF value of the SMB:

DCF = $13 million