Where a business plan is used to seek equity funding from private equity investors or venture capitalists, care must be taken to develop a sound financial plan. Sometimes, companies seek the help of business consultants to assist in the process for valuation of the private company, especially for complex businesses.
The Discounted Cash Flow (DCF) method for small business valuation is used to estimate the investment potential of a business private company or a business venture. Discounted cash flow analysis through the DCF method uses free cash flow projections and discounts them to arrive at a present value and DCF terminal value for a small business valuation. A winning cash flow business will ideally have a stellar business valuation.
In this article, an entrepreneur developing discounted cash flow valuation for a business plans can expect to:
- Understand the steps in preparing cash discounted flow valuation for the small business
- Question accounting assumptions and estimates
- Evaluate and analyze the data needed for a cash discounted flow DCF valuation for a small business valuation
- Question management’s projections and estimates
- Perform cash flow analysis
- Create the DCF valuation model on a DCF excel spreadsheet
In an introduction to financial projections for a business plan, Financial Projections for Business Plans had introduced Company XYZ which clearly had to conceptualize and formulate business strategies to strengthen the current business, weed out low or no margin customers, identify new business opportunities and reduce costs. The case of company XYZ sets a foundation for exploring the DCF method behind a typical Discounted Cash Flow (DCF) valuation for the small business valuation. The case provides ample information, both qualitative and quantitative in nature, which can be used as inputs in a DCF small business valuation model. Hence the case allows the entrepreneur to test core business assumptions and assess which are the right inputs in order to help the entrepreneur value his/her company.
Discounted cash flow valuations can be used in a variety of instances, including for restaurant small business valuation or a property analysis spreadsheet in property investments and restaurant business investments. For example, Commercial Real Estate valuation software utilizing valuation methodology offers excel based financial models. Thereafter, performing cash flow analysis will allow the entrepreneur to further analyze the restaurant business, property valuation or the e-commerce business.
How to Develop Financial Projections for a Business Plan
Entrepreneurs can first discuss the soundness of the business plan used for the small business valuation which will result in a winning cash flow business. The entrepreneurs can then turn to the financial analysis, first developing pro-forma income statements and then cash flow projections. When valuing a company using discounted cash flow analysis, they will discuss and assess the data needed to input into a DCF model, which approaches to use to arrive at the Net Present Value (NPV) and DCF terminal value as well as what estimates need to be questioned. They will also make necessary assumptions for the small business valuation and then proceed to do the cash flow notes on the cash flow analysis.
The Value of a Company is in the Eye of the Beholder
Small business valuation done by business plan consultants is more of an art rather than a science. Perhaps a simple question needs to be answered first: “Who developed the business plan and what is the significance of that?” This question may throw off some of the entrepreneurs. However, the question is meant to drill home the point that “value is in the eye of the beholder.”
The entrepreneur has to understand that different people can arrive at different DCF valuation figures – depending on who they are and their intentions behind valuing the startup or private company. In this case, it is the entrepreneur, the CEO and founder of XYZ, for whom it is in his best interests to generate as high a small business valuation figure as possible. Hence, entrepreneurs should put themselves in the shoes of an independent small business valuation professional in order to assess the reasonableness and soundness of the business plan.
How to Prepare a Discounted Cash Flow (DCF) Valuation Model like Business Plan Consultants
To go about doing this, one firstly has to understand how to value a company using the DCF method:
- Forecast free cash flows available to equity holders (or to debt and equity holders) over a finite forecast horizon (usually 5 to 10 years) for the winning cash flow business
- Forecast free cash flows beyond the terminal year based on some simplifying assumption
- Discount free cash flows to equity holders (debt plus equity holders) at the cost of equity (weighted average cost of capital). The discounted amount represents the estimated value of free cash flows available to equity (debt and equity holders as a group)
- Input all necessary data into the DCF model on a DCF excel spreadsheet, including discount rate
- Calculate Net Present Value (NPV) and the DCF terminal value for the small business valuation
The entrepreneur should then proceed to obtain the above information in order to build a DCF model on a DCF excel spreadsheet. This discussion should also encompass the practical issues in obtaining data that management may not be able to provide, such as beta, risk free rate, market risk premium and the appropriate weighted average cost of capital (WACC).
Even in instances where management provides such details, the independent small business valuation professional should strive to obtain such details by himself/herself. Special software such as Bloomberg can be used to obtain these details with ease, particularly for a restaurant cash flow valuation, DCF for e-commerce start-up and a property DCF valuation spreadsheet. Cash flow software, cash flow analysis and investment analysis software are often widely available, even at the local library. Amongst such software includes real estate investment software, cash flow software, valuation software and business planning software.
Jo Bilson - Jo Bilson is a management consultant with interests including venture capital and entrepreneurial finance.
