Discounted Cash Flow Model: It's Not as Difficult as You Think

Posted by Skillfin Learning on April 1st, 2021

A DCF model is a type of financial model used to determine the value of a company. A DCF model is essentially a projection of a company's unlevered free cash flow discounted back to today's deal, known as the Present Net Value (NPV). Here is a brief about Discounted Cash flow model that will help you to know about the fundamentals.

Even though the definition is necessary, many components require a significant amount of technical background information. You can study the statement financial model, which connects the financial statements, which is the foundation of  a DCF model.

In a DCF model, how do you make a cash flow forecast?

This is a broad subject, and there is a real science to forecasting a company's results. In simple terms, a financial analyst's task is to make the most educated prediction possible on how each of a company's drivers will affect its future performance. For more details, below is the list of essential points necessary for assumptions and forecasting.

1. Sales forecasting

There are several approaches to developing a sales forecast, but they can be divided into growth-based and driver-based.

2. Cost forecasting

A comprehensive and granular expense forecast can be made, or a simple year-over-year comparison can be performed. The most comprehensive strategy is known as a Zero-Based Budget, and it entails starting from scratch with little regard for what was spent the previous year. Typically, each department in the organization is asked to explain any cost based on the operation.

3. Capital asset forecasting and working capital shifts

After you've completed the majority of the income statement, it's time to forecast capital assets. Since PP&E is often the largest balance sheet component, capital expenditures and depreciation must be modeled separately. Each of the significant capital assets in the DCF model, then combine them into a single overall schedule. There will be several lines on each capital asset schedule: opening balance, CapEx, depreciation, dispositions, and closing balance.

4. Financial structure forecasting

The way you build this section will be primarily determined by the type of DCF model you're creating. The most popular solution is to maintain its current capital structure, assuming no significant adjustments other than established factors, including debt maturity.

5. Value at the End

A DCF model's terminal value is hugely significant. It often accounts for more than half of the business's net present worth, mainly if the forecast period is less than five years. The constant growth rate approach and the multiple exit approaches are two methods for calculating the terminal value.

6. Cash Flow Timing

In a DCF model, it's essential to pay careful attention to cash flow timing because not all periods are created equal. At the start of the model, there is always a "stub phase" where only a portion of the year's cash flow is obtained. Furthermore, the cash outflow making the actual investment takes a long time before the stub is received.

Conclusion: You can learn everything about Discounted cash flow model via Skillfin Learning's Online classes.