To do well in the services market, managers must aim at the innovation of their production tools, as well as the development of their skills related to administrative processes. In this case, we highlight the need to learn about concepts and strategies concerning matters of the financial sector, given that this department has great relevance for the health and sustainability of any business.
Thus, professionals who are assigned to deal with processes in this area must try to learn about the main aspects involving the company’s capital and profitability, such as the discounted cash flow. Do you know what this is? To help you understand it better, we’ve prepared this article with the main information.
Read on and stay on top of it!
Discounted Cash Flow (DCF) is nothing more than a capital budgeting technique that uses as a parameter the expected cash that may be produced by the company in the future, providing an overview of the current value. The main goal is to translate the enterprise’s future cash flow into current amounts by setting a discount rate.
For you to understand better, let’s compare the DCF with the normal cash flow. The former shows an estimate of the corporation’s value based on the profit it can generate. On the other hand, normal cash flow refers to the amount of capital transacted by the company in a given period.
DCF is a powerful strategy to guide the decisions made by managers and investors. As we’ve pointed out, by using this method, you can create an estimate of the return a business can deliver. Furthermore, the tool also makes assessing opportunities and threats possible, as it measures future returns based on the discounts and risks assumed.
The formula to calculate DCF is relatively simple – just divide the amounts referring to the future cash flow by the number of periods (estimated years), multiplying by a discount rate adding up to one unit. Thus, the formula is:
DCF = revenue projections / 1 + discount rate raised to the numbers of periods considered
It is worth noting that the discount rate refers to the financial devaluation in each period. As an example, suppose that a company has as a projection over a period of 3 years the revenue of:
Based on a 12% discount rate, we will have to discount this interest each year. Using the formula, we have:
Now that we know the revenue for the next 3 years, referring to the approximate amount of what it would be today, just add and find the enterprise’s value:
DCF = 53 + 63 + 64
DCF = $ 180 THOUSAND
So, these were the key information about what Discounted Cash Flow is and how to calculate it. With this amount in hand, it is possible to prospect investors for your company and demonstrate the potential and expected future revenue. Due to its relevance, this calculation must be done carefully, taking into account the correct amounts for each year.
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