Discounted cash flow, explained properly
The method that intimidates people. What it does, how it is built, and exactly how much the answer moves when the assumptions move.
If somebody has put a discounted cash flow in front of you, you are entitled to understand it before you agree to anything built on it. The method starts from something obvious. A euro you receive in five years is worth less than a euro today. So if you want to know what a business is worth now, forecast the cash it will produce and reduce each future year back into today's money.
It is not simple to do well. Anyone who tells you it is has either not built one or is about to show you a spreadsheet you should not trust. The arithmetic is easy. The assumptions are where the difficulty lives, and small changes in them move the answer a long way.
That sensitivity is not a reason to ignore the method. It is the reason we never use it on its own, and it is the reason this page shows you the sensitivity rather than describing it.
The idea, in one calculation
Suppose someone promises you €100,000 in three years, and suppose you would need a twelve percent annual return to take that risk rather than doing something else with your money.
Then the promise is worth €100,000 divided by 1.12, three times over. That is €71,178 today. Discounting is nothing more complicated than that, repeated for every year of a forecast.
The two things you had to choose were the €100,000 and the twelve percent. Everything difficult about the method is contained in those two choices, and neither of them is a fact.
How a valuation is actually built
- Forecast the free cash flow. Not profit. The cash left after tax, after the equipment spending needed to keep going, and after the working capital that growth consumes. Usually five years, because beyond that a forecast for a private business is not credible.
- Choose a discount rate. The return a buyer needs in order to justify the risk. Built from the cost of equity and the cost of debt, weighted by how much of each will be used.
- Put a value on everything after year five. The business does not stop. The terminal value stands for every year beyond the forecast, and it is usually the largest single component of the answer.
- Add it up and adjust. Sum the discounted cash flows and the discounted terminal value to get enterprise value. Then subtract debt and add surplus cash to reach what the shares are worth.
Step one is the one owners underestimate, because free cash flow is a long way from EBITDA and the difference is the subject of its own guide. Cash flow and working capital
A model you can check
Free cash flow starting at €500,000 and growing three percent a year. Discount rate twelve percent. Growth after year five, two percent a year forever.
Five years, discounted at twelve percent| Year 1: €500,000 discounted | €446,400 | |
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| Year 2: €515,000 discounted | €410,600 | |
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| Year 3: €530,450 discounted | €377,600 | |
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| Year 4: €546,364 discounted | €347,200 | |
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| Year 5: €562,754 discounted | €319,300 | |
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| Everything after year five, discounted | €3,257,200 | Year five cash grown by two percent, divided by the twelve percent discount rate less the two percent growth rate, then discounted back five years. |
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| Enterprise value | €5,158,300 | |
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Now look at the composition. €1,901,100 of that came from the five years anybody actually forecast. €3,257,200 came from the single line covering everything afterwards. That is 63 percent of the answer resting on one assumption about the indefinite future.
The discount rate, and where country risk belongs
The discount rate is the return a buyer requires. A safe, predictable, contracted stream of cash gets a low rate. A business with three customers in a volatile sector gets a high one. The rate is doing the same job as the multiple in an earnings valuation, only explicitly.
It is also the correct home for country risk. A business in a country with a higher cost of capital is worth less for the same cash flows, and the discount rate is where that belongs, because that is what the difference actually is. It should not be applied by reducing the multiple instead. There is no published mapping from country risk to a number of turns of EBITDA, so anyone doing it that way is inventing the conversion.
One consequence is worth knowing in advance. If country risk enters through the discount rate, then the cash flow valuation and the multiple valuation will not move together, and they will disagree more in higher risk countries. That is the correct behaviour rather than an inconsistency, and a valuation should disclose it rather than quietly harmonise the two.
How far the answer moves
This is the section that should determine how much weight you give the method. Same business, same forecast, same terminal growth. Only the discount rate changes, and every one of these rates is defensible for a private company of this size.
The same business at three discount rates| At 12 percent | €5,158,300 | |
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| At 13 percent | €4,686,400 | One percentage point. The value falls by €471,900, about nine percent. |
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| At 15 percent | €3,960,600 | Three percentage points. The value falls by €1,197,700, about twenty three percent. |
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Nobody made an error. Nobody was dishonest. A single analyst preference, well inside the range two competent people would argue over, moved the valuation by nearly a quarter.
This is why a discounted cash flow presented as a single confident number should make you more suspicious rather than less. The precision is real in the arithmetic and absent in the inputs.
It also explains a pattern you may already have noticed. When a party has an interest in a high valuation, their discount rate tends to be at the low end of the defensible range and their terminal growth at the high end. Neither choice is provably wrong on its own. Together they move the answer by more than most negotiations ever do.
When it is worth relying on, and when it is not
| Worth relying on | Treat with caution |
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| Revenue | Contracted, with known end dates. | Won again every year from a standing start. |
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| The forecast | Built from an order book you can show. | Built from a growth rate somebody chose. |
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| The business | Infrastructure, long concessions, anything with a defined life. | Early stage, or recovering from a bad period. |
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| Track record | You have hit your last three forecasts. | This is the first forecast you have written. |
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For most owner managed European businesses, the earnings multiple is the better primary method, because it reflects how the transaction will actually be negotiated. The discounted cash flow is the cross check. It answers a different and useful question: does the price a buyer is offering make sense given the cash this business can realistically produce?
When the two methods agree, you have a number that will survive scrutiny. When they disagree sharply, the disagreement is telling you something specific, and it is usually about the forecast.
The Argos Mid-Market Index is a quarterly index published by Argos Wityu, a European private equity firm, with Epsilon Research. It tracks what buyers actually paid for mid sized European businesses.
In Q1 2026, the overall median was 8.6×. Trade buyers paid a median of 7.8×, while investment funds paid a median of 10.0×.
Scope: eurozone UNLISTED companies, equity value €15M to €500M, majority-stake acquisitions, six-month rolling median.
EXPLICIT EXCLUSIONS: financial services, real estate, and high-tech / technology sectors are not included in the Argos Index universe.
Read the source from Argos Wityu / Epsilon Research
The index above is what we cross check against. If a discounted cash flow produces a value equivalent to fourteen times your profit while comparable businesses are changing hands at eight, the cash flow model is not revealing hidden value. It is telling you that its own assumptions are optimistic, and a buyer will reach that conclusion faster than you would like.
See both numbers for your own business
We run the earnings multiple and the cash flow method separately, show each result, and show where they disagree, because the gap between them is usually the most informative part of the report.
It is free and takes about ten minutes.
Step one of three: see your number, free, with no account and no name.
See what it's worth