This DCF analysis infographic walks you through the process, step by step, of how to build a discounted cash flow (DCF) model to value a business.
A discounted cash flow model takes into account all the factors that could affect a company’s current and future performance. The performance equates to certain inflows and outflows of cash, which are then discounted back to the present value. The sum of the present value of all future cash flows equals the net present value (NPV).
There are two categories of influence on the value of a business:
Internal Forces Impacting DCF Analysis
The internal side consists of most of the data that a financial analyst has to consider when generating models. It includes the historical performance of the company, its current operations, and its future potential.
The internal side also often has the most concrete or solid data, since most of the raw information used in the models is quantitative.
A financial analyst, for example, will use a historical income statement to forecast future net income. The forecast will eventually flow down through other financial statements and the supporting schedules to generate an estimate of future free cash flow. The cash flow is what is used in the discounted cash flow analysis.
It is important, however, to remember that the external side should be considered too. While the internal side of the DCF analysis is important and key to the quantitative side of the analysis, external factors must not be neglected when considering the future potential of a company.
External Forces Impacting DCF Analysis
External forces, such as the market cycle and the growth of competitors, will indefinitely have an impact on the performance of any company. While these are harder to forecast, educated and informed estimates must be made of these factors if one wishes to make a more accurate DCF model.
The infographic was designed to help you visualize the process of how to actually think about a DCF analysis in your head before building a DCF model.
Please read through the various steps described in the image above to master the process step by step.
Thank you for reading this guide about CFI’s DCF analysis infographic. CFI’s mission is to help anyone in the world advance their career as a financial analyst. With that in mind, these additional CFI resources will help you on your way: