What is the DCF method and when to use it?

The Discounted Cash Flow (DCF) method is standard for startups but often rejected for stable SMEs. It values a company based on projected future cash flows discounted back to today. In the pragmatic Swiss culture, relying on long-term forecasts is viewed with skepticism ('DCF stands for Dreams Come False'). ### Technical Explanation The DCF method is widely regarded in corporate finance theory as the most 'accurate' intrinsic valuation tool. However, in the Swiss SME market, its application is nuanced. #### The Mechanics of DCF The valuation is the sum of the present value of: 1. Projected Free Cash Flows (FCF): Explicit forecast of distributable cash for 5 to 7 years. 2. Terminal Value (TV): The value beyond the horizon, often accounting for 60-80% of total value. This makes the valuation sensitive to the assumed long-term growth rate. #### The Problem with DCF for SMEs For a traditional 'Brick & Mortar' SME, DCF is often viewed with skepticism by local banks. The method is highly sensitive: a 1% change in WACC can swing valuation by 20%. Buyers of stable SMEs prefer the certainty of historical EBITDA multiples. #### When DCF is Essential * Startups / High-Growth: For companies with negative current EBITDA but high potential (e.g., Biotech, SaaS). * Finite Life Assets: Companies with a defined lifespan (e.g., quarries). * M&A Pricing Validation: Sophisticated buyers run a DCF as a 'sanity check'.