The discounted cash flow valuation method is undoubtedly one of the most widely used in corporate finance to estimate the value of the company under analysis. However, despite its widespread use, numerous errors are made in cash flow forecasting.
The discounted cash flow (DCF) method has two fundamental activities:
Both run the risk of having errors in the process of their calculation.
DCF is based on the company's capacity to generate wealth in the future. Thus, the method is based on estimating future cash flows and discounting them at a rate appropriate to the cash flow rate used.
Broadly speaking, the cash flow forecast is based on the company's current financial statements and, according to some hypotheses on sales growth, margin maintenance, estimated capex, etc., the profit and loss accounts and the balance sheet can be constructed, from which the cash flow statement is obtained.
Once obtained, the appropriate operations can be performed to obtain the desired cash flow: cash flow for the shareholder, cash flow for debt, free cash flow or capital cash flow.
This activity, despite its apparent simplicity, presents numerous risks and errors that can be made and, therefore, affect the correct valuation of the company in question. The most common errors are set out below:
Evidentemente, dependiendo del flujo de caja que se quiera utilizar, habrá que prestar especial atención a qué se incluye y qué se excluye del mismo.
Por ejemplo, tomando el flujo de caja libre, el más común, no puede olvidarse de que representa la cantidad de dinero de la que dispondrá la compañía para pagar la deuda externa y/o retribuir a sus accionistas. Se trata del dinero que obtendrá la empresa una vez satisfechas todas sus necesidades operativas y de inversión. De esta manera, se obtendrá partiendo del beneficio antes de intereses e impuestos menos los impuestos sobre el mismo, sumando las amortizaciones y depreciaciones, y restando la inversión en activos fijos y NOF.
Tener esto en cuenta nos ayudará a no incluir partidas o flujos que no deben tenerse en cuenta en este caso concreto. Del mismo modo ocurrirá con los distintos flujos de caja. Si se entiende bien qué representa y cómo calcularlo, se evitarán errores en su cálculo.
In spite of the importance of the NOF in any company, they are often forgotten when analyzing the company. They should always be included in the cash flow forecast as they represent cash outflows by the company that are unavoidable for the daily operation of the company's activities.
It is not correct to add an increase in cash as cash flow to shareholders since part of this increase will be necessary to continue operations and in many cases the cash is not expected to be distributed immediately.
However, it may be correct to add cash if the cash is distributed immediately, the rate of interest received on cash is the same as the rate of interest paid on debt, or the cost of debt used in the WACC is the weighted average of the cost of debt and the rate of interest received on cash.
The effective tax rate of the leveraged company should be used when calculating free cash flow. Errors arise when using the taxes paid (in € or $ amount) by the leveraged company or the statutory tax rate or one different from the leveraged company's tax rate.
It can only be considered as such when the expected profit coincides with the flow available for the shares. This occurs in only two cases:
As it can be deduced, these two scenarios are very unlikely because they assume conditions that are rarely present in companies. Therefore, in the vast majority of cases, the profit cannot be considered as a flow.
As in the case of the error detailed above, this will only occur in very special situations and conditions, which do not usually occur in most companies.
It may happen that when performing a sensitivity analysis by constructing different scenarios, the flows in the worst case scenario exceed those of the best case scenario. This is obviously illogical and will be due to some error in the calculation of the flows that will have to be reviewed.