The benefits of the DCF method in valuing SMEs
When valuing SME companies, many advisors quickly resort to a multiple method: fast, recognizable, and easy to explain. Yet, particularly within the SME sector where companies can differ significantly, the discounted cash flow (DCF) method often provides a more complete and better substantiated picture. For you as an accountant or financial advisor, it is important to understand when and why this method offers added value.
1. The DCF method looks forward, not backward
While a multiple method relies on historical transactions of other companies, the DCF method reasons from the company’s own future cash flows. For an SME with concrete growth plans, a new product line, or a changing business model, this is a significant advantage: the valuation aligns with what the company will actually earn, rather than what comparable companies once yielded.
2. Incorporating company-specific risks
With the DCF method, you incorporate the company’s risk profile directly into the discount rate. Dependency on the owner, a concentrated customer base, or a vulnerable market position: these are all factors that you can explicitly weigh. This makes the outcome more tailored and better substantiated than a generic sector multiple, which simply cannot capture these types of nuances.
3. Insight into value drivers
A DCF calculation forces you to thoroughly understand the company’s business model: revenue growth, margin development, investment needs, and working capital. This results not only in a valuation but also in valuable insight for your client. You can demonstrate which levers actually drive value, and that is precisely the kind of advisory service that sets you apart.
4. Scenarios make the valuation tangible
Since the DCF method is built on assumptions, you can easily calculate various scenarios. What happens to the value in an optimistic growth scenario, or conversely, with disappointing margins? For entrepreneurs considering an investment or thinking about succession, this type of insight is often more valuable than a single figure.
5. Better substantiated for buyers and financiers
Banks, investors, and buyers ask critical questions. A valuation based solely on a sector multiple is then easily contestable. A DCF analysis, built on substantiated assumptions regarding revenue, costs, and risk, provides a stronger starting point in negotiations and strengthens your client’s position.
Better and high-quality advisory for the client
A key advantage of the DCF method is that all underlying assumptions are made explicit. Growth expectations, margins, investments, and risks are fixed within the model and are therefore open to discussion. This increases the transparency of the valuation and makes it easier to test or adjust assumptions.
This does not mean the multiple method is redundant. Actual market transaction prices remain a valuable benchmark to weigh your outcome against. However, it is important to know within which company size these transactions were measured, as multiples for smaller companies typically deviate from those for larger enterprises. If both methods yield approximately the same result, the valuation is all the more robust. If there is a significant difference, it often serves as a reason to take another close look at the assumptions behind your DCF calculation.
For you as an accountant, this is an excellent opportunity to strengthen your advisory role. You know your client’s figures and prospects better than anyone. A DCF analysis not only provides a more substantiated valuation but also serves as an excellent starting point for a strategic conversation about value creation.
Curious about how to support this process with software? Try out ValuePartner’s business valuation software.