Understanding Discounted Cash Flow (DCF) in Business Valuation

Wondering what a business or investment is really worth?

Discounted cash flow (DCF) helps you figure out what something is worth by estimating its future cash flow and adjusting it to today’s value—because money today is worth more than the same amount later.

DCF factors in the time value of money to help you make smarter decisions. It’s especially useful when investing, buying a business, or pitching to investors. In short, it turns “what ifs” into reliable numbers you can trust.

In this article, we’ll explain how DCF works, give a simple example, and show how technologies like QuickBooks can make it even easier.

What is discounted cash flow?

Discounted cash flow (DCF) is a method for estimating the future value of a business, asset, or investment. It shows you how much something is worth today by looking at how much money it will earn in the future.

Many companies utilise DCF to help them decide when to buy assets, start projects, invest in other companies, or even leave a business. 

Using DCF, businesses can figure out if an investment is worth it by discounting future cash inflows at the right rate. If the DCF value is greater than the cost of the investment, then it may be a good financial decision.

Ultimately, DCF gives both business owners and investors the ability to evaluate opportunities in monetary terms and make data-driven decisions that align with their financial goals and risk appetite.

The importance of DCF in financial analysis

The discounted cash flow (DCF) formula helps you estimate how much money an investment could generate and what a business is really worth.

It gives you a structured way to evaluate opportunities and uncover their true value—so you can make smarter financial decisions based on facts, not just gut feelings.

Plus, DCF allows businesses to test different scenarios, such as market changes or cost shifts, and measure the impact on value.

The discounted cash flow formula explained

The discounted cash flow (DCF) formula answers a simple question: “If I invest in this opportunity, what’s it really worth today?”

In short, DCF calculates the present value of the cash your business will earn in the future, adjusted for both time and risk. Because let’s face it: a dollar five years from now isn’t worth the same as a dollar today, due to risk, inflation and the fact that you could be using that money elsewhere in the meantime.

Here’s the formula:

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

Where:

• CFₜ = Cash flow in year t
• r = Discount rate (expected return or cost of capital)
• t = Time period (in years)

Let’s say you’re investing S$50,000 to expand your café and expecting S$15,000 annually in free cash flow for five years. The DCF formula will show you what that is worth today, considering both the risk and the opportunity costs, letting you see a fact-based view of long-term value.

Key components of the DCF formula

Before you dive into the numbers, you need to understand the four key components of a solid DCF model:

• Cash Flows (CF): These are the foundation of the DCF—projected future free cash flows. They are what is left after expenses, taxes and reinvestments.
• Discount Rate (r): This reflects the return investors expect, often based on the company’s WACC. A higher risk means a higher rate.
• Time Periods (t): Usually 5-10 years, with each period representing when a cash flow is expected.
• Terminal Value (TV): Measures the future value of a business at the end of the projection period (usually 5 years). It forecasts the perpetual growth rate.

Step by step guide to calculating DCF

Calculating discounted cash flow (DCF) might sound technical, but it’s easier than you think. Here’s a simple breakdown to help you get started:

1. Forecast your business’ free cash flows

Start by estimating your business’ free cash flows. This is the money that is left over after covering operating costs, taxes, reinvestments, and other expenses. Typically, with DCF, you would forecast for 5-10 years depending on your business’s stability, using real data from past performance to make reasonable assumptions. 

It’s important that you don’t just guess; you should look at sales trends, upcoming expenses, and industry growth.

2. Choose a discount rate

The discount rate reflects the risk involved and the return an investor expects. Many businesses use their weighted average cost of capital (WACC). The higher the risk, the higher the rate you should apply in your calculations.

3. Calculate present value

Now, it’s time to apply the DCF formula to each future cash flow to “discount” it back to today’s value. Remember, money in the future is worth less today, due to inflation and other factors.

4. Estimate terminal value

This is how much your business is worth after your projection ends. You can estimate it using either the perpetual growth method (assuming it grows at a steady rate forever), or an exit multiple based on industry benchmarks.

5. Discount the terminal value

Just like the yearly cash flows, this figure also needs to be discounted back to today’s value to give you an accurate representation.

6. Add it all up

Now that you have everything you need, you just need to sum up the present values of each year’s cash flow, plus the terminal value. That total is your business’ intrinsic value today.

Let’s say your DCF estimate is S$800,000, but the asking price is S$600,000. That could be a great investment opportunity.

To get a better picture, you can try running different scenarios with conservative and optimistic estimates, especially if you’re planning a big financial move.

Determining the appropriate discount rate

The discount rate reflects the return you expect and how risky the investment is. It’s the rate used to adjust your future money to today’s value.

Most businesses use the Weighted Average Cost of Capital (WACC), which combines the cost of borrowing with investor expectations. The higher the discount rate, the riskier the investment is seen to be.

For example, a startup might use 15-20% due to uncertainty, whilst a more established business might use 8-10%.

If you’re unsure, be conservative. It’s smart to run a sensitivity analysis and see how a 1-2% change in the rate affects your valuation. If a small tweak makes a big difference, there’s more risk in your assumptions.

This step is important, as it reveals how solid or shaky your valuation really is, helping you make more informed decisions.

Discounted cash flow calculation example

Here is an example to help you better understand the usefulness of the DCF formula.

Let’s say you’re considering buying a small cacafé in Singapore. The current owner shares their projected free cash flows—the money left after operating expenses and reinvestments - for the next 5 years:

• Year 1: S$50,000
• Year 2: S$60,000
• Year 3: S$70,000
• Year 4: S$80,000
• Year 5: S$90,000

At the end of the fifth year, they expect to sell the café for S$100,000. That future sale price is called the terminal value (a key part of the DCF model which estimates what the business will be worth beyond your forecast period).

To figure out whether this is a good investment today, we need to adjust all those future values using a 10% discount rate to reflect both the time value of money and the risk involved.

Here are the numbers when discounted:

• Year 1 PV = S$45,450
• Year 2 PV = S$49,590
• Year 3 PV = S$52,630
• Year 4 PV = S$54,880
• Year 5 PV = S$55,900
• Terminal Value PV = S$62,090
• Total DCF Valuation: S$320,540

So, what does this tell you? If the asking price is S$300,000, the café might be a good buy. But if they’re asking S$350,000, the deal may be overpriced—unless you’re sure you can improve performance or reduce risk.

With this discounted cash flow calculation example, you can see how DCF can help you make sense of investment decisions.

Applications of DCF in Singaporean businesses

In Singapore, the DCF method has become a trusted tool across various industries. Because it doesn’t just tell you what something costs, it helps to reveal what it is truly worth today, based on its ability to generate cash in the future. It cuts through market fluctuations and focuses instead on long-term fundamentals.

It’s applied in all kinds of sectors:

• Startups: Founders and investors use it to value early-stage companies.
• Mergers and acquisitions: Buyers can use DCF to assess acquisition targets and justify valuations.
• Real estate: Investors may use DCF to determine the value of commercial or rental properties based on forecasted rental income and resale value.
• Corporate finance: CFOs use DCF in budgeting, project appraisal, capital planning, and more.
• Accounting and compliance: Accountants can apply DCF in impairment testing and fair value assessments.

Because DCF reflects intrinsic value rather than market sentiment, it supports rational, data-driven decisions that are useful to businesses of all sizes.

Limitations and considerations of DCF analysis

The DCF method is a powerful valuation tool, but it isn’t foolproof. Predicting future revenue, costs, or cash flow is inherently uncertain, and even small misjudgements can lead to major shifts in value. 

It’s also highly sensitive to the discount rate. For example, a change of only 1% can significantly alter the end result, especially over longer forecast periods.

Another issue may fall with the terminal value, which often makes up a large portion of the total valuation. If your growth assumptions are too optimistic, you may value an investment decision at a higher number than it’s actually worth.

DCF also focuses purely on internal financials, without factoring in real-time market dynamics or competitive shifts, unless explicitly built in.

Because of this, DCF is best used alongside other methods, like market comparisons or transaction analysis, and tested with multiple scenarios. This allows you to assess how robust your valuation is under different conditions.

Enhancing DCF analysis with QuickBooks tools

The DCF formula is already a powerful tool, but when you pair it with QuickBooks, you can take it even further.

QuickBooks helps you enhance your calculations and streamline your financial data, making smarter decisions easier than ever.

• Real-time financials: Access updated profit and loss statements, balance sheets, cash flows and more, to give yourself a clear picture of your finances.
• Cash flow forecasting: Use tools like the Cash Flow Planner to anticipate future inflows and outflows, helping you get a clearer picture of your income.
• Scenario planning: You can model different financial outcomes with budgeting and forecasting features, helping you to be better prepared for your financial future.

With these tools, you can create reliable financial projections for your DCF analysis.

QuickBooks cuts down the manual work of compiling data and helps you avoid spreadsheet errors. Your assumptions stay grounded in accurate, up-to-date numbers—giving you the clarity and confidence to adapt to changing business conditions.

Conclusion: Leveraging DCF for informed financial decisions

For business owners and investors in Singapore, DCF analysis provides a method to assess whether an opportunity truly adds value over time, and whether it’s worthwhile.

When you use the DCF formula alongside tools like QuickBooks to access and forecast your financial data, you can analyse opportunities with clarity, rather than relying on intuition or market buzz. In today’s uncertain economy, that kind of insight could be what separates a smart move from a costly mistake.