DCF and multiples: two methods that check each other
Why independent valuation reports often combine discounted cash flow analysis with market multiples, and how the two methods are used to cross-check results.
Discounted cash flow analysis estimates a company's value from its projected future cash flows, discounted to the reference date, while a multiples approach derives value from how comparable companies are priced relative to earnings or revenue. Independent valuation reports often apply both, using each as a check on the other rather than relying on a single figure.
- DCF values a company from its own projected cash flows and a discount rate.
- Multiples derive value from how comparable companies are priced in the market.
- Using both methods together helps identify whether a result is an outlier.
Discounted cash flow starts from the company's own projections
A discounted cash flow analysis builds a value from the company's expected future cash flows, typically over a period of several years, plus a terminal value representing the period beyond. These cash flows are then discounted back to the reference date using a rate that reflects the risk associated with the business and its financing structure.
This method is well suited to a company with a track record that supports reasonable projections and a business model that can be reasonably extrapolated. It is more sensitive to the quality of the assumptions used, since small changes in growth or discount rate can shift the resulting value considerably.
Multiples derive value from comparable companies
A multiples approach looks at how similar companies, whether listed or subject to recent transactions, are valued relative to a financial metric such as EBITDA or revenue. That ratio is then applied to the subject company's own figures to estimate a value.
This method depends on finding companies that are genuinely comparable in size, sector, growth profile and capital structure, which is not always straightforward for smaller or highly specific businesses. Where comparables are scarce, the resulting range tends to be wider.
Each method has known limitations
Discounted cash flow analysis relies on projections that are, by nature, uncertain, and on a discount rate that involves judgment. A small business with limited financial history or an unusual capital structure can be harder to model with precision using this method alone.
A multiples approach, in turn, can be distorted if the available comparables are not truly similar, or if market conditions at the time of comparison differ from the company's own circumstances. Neither method is free of assumptions.
Combining methods produces a cross-check rather than an average
When a valuation report applies both approaches, the purpose is not to average the two results mechanically. It is to see whether they point in a similar direction, and if not, to understand why. A wide gap between the two often signals that one set of assumptions needs closer scrutiny.
Where the methods converge within a reasonable range, this adds confidence that the resulting value is not an artefact of a single method's weaknesses. Where they diverge, the report typically explains the reasons and how the final value was reasoned.
Choosing methods depends on the company's profile
For a company with stable, predictable earnings and good visibility on future performance, discounted cash flow analysis tends to carry more weight. For a company operating in a sector with active comparable transactions, multiples can offer a more market-grounded reference point. In many cases, both are presented side by side in the report.
Questions on this
Is one method more accurate than the other
Neither method is inherently more accurate. Each relies on different assumptions and works better for different types of companies, which is why independent valuation reports commonly apply both and compare the results.
What happens if DCF and multiples give very different results
A significant gap usually points to an assumption that needs review, such as a growth rate, discount rate, or the choice of comparable companies. The report typically explains the divergence and how the final value accounts for it.
Does a small company need both methods applied
It depends on the available information. Where reliable projections or comparable companies are hard to establish, a report may rely more heavily on the method best supported by the data at hand.
Open a file
Enter your details and we will get in touch shortly.
Read next
This information is general. It does not take your specific situation into account and is not tax advice.