Discounted Cash Flow, step by step

Before a single number, fix the idea in your head, because everything else is just bookkeeping in service of it. A business is worth the cash it can hand its owners over the rest of its life — and cash that arrives far away, or uncertainly, is worth less to you today. A discounted cash flow, or DCF, is simply the disciplined way of turning that one sentence into a number you can act on.

Notice what a DCF is not. It is not about last quarter's profit, the share price chart, or what a broker thinks. It is about the cash — the actual rupees the business can pull out and give to the people who own it, after paying for everything it needs to keep running and growing. Profit is an accounting opinion; cash is a fact. A DCF deliberately works in cash because cash is what you can spend.

1. 1Forecast the cash. Estimate the free cash the business throws off each year, for a handful of years you can see.
2. 2Discount each year back to today. Shrink every future year's cash to its present value, shrinking the distant years harder.
3. 3Add a terminal value, then sum it all. Bundle everything beyond the forecast into one lump, discount that too, and total everything into one number — the value of the whole business today.

One promise and one warning. The promise: by the last step you will be able to do this yourself, not just nod along. The warning: a DCF produces a confident, specific number, and that confidence is seductive and often false. We'll spend the final steps learning to distrust our own output. Hold the answer loosely. The discipline of building it is worth more than the number it spits out.