When it comes to making a valuation of a company For discounted cash flow valuation, it should be borne in mind that a simple long-term financial projection is not enough. In order to achieve a correct and consistent valuation, certain steps must be followed.
On the one hand, the first thing to look at is the company itself and the sector. When it comes to look at the companyIn the case of the latter, a thorough financial analysis must be carried out, in which the following factors must be observed:
In addition to these, the development of the company's financing, the analysis of the company's financial health and the weighting of the company's current risk are other key factors that differentiate a good financial valuation from a bad one.
Once this section has been completed, it is important to proceed with a strategic and competitive analysisThis means knowing the company and the sector inside out.
In this case, knowledge of the sector, of the main players, key drivers that are affecting the evolution of the sector are a good way to start.
This analysis should then be followed by identifying the value chain, understanding the company's capabilities and competitive position in order to understand the company's environment, the functioning of the industry and the current situation of the company in relation to its competitors.
Once the guts of the company and the sector are known, the next step comes from projecting the company's future cash flows. This requires forecasts of the industry, the company's competitive position and that of its competitors.
Once this has been done, it is possible to have an understanding of the situation that the company may face in the future, which will then be used to make financial forecasts.
These financial projections should be made on all three financial statements, cash flow, balance sheet and income statementThe main emphasis is placed on planned investments, financing and cash flow generation capacity, and this section is concluded after the calculation of the terminal value of the investment.
In this step, it is very important to have certain scenarios in place, in order to be able to see how different variations in inputs may affect the company and to be able to create contingency plans that help to redesign the strategic plan in case of worse than expected situations.
Finally, this type of projections should be reviewed to see if
have a certain consistency, thus avoiding under- or over-weighting. To this end, it is important to compare these projections with forecasts of historical figures and the historical ability to deliver on the company's strategy, among others.
Once the projections have been set up, it is important to be aware of what is the required profitability for each business unit and for the company as a whole.
This takes into account both the cost of debt and the required return on equity, i.e. it is calculated as follows the weighted average cost of resources. A calculation that must be made with great care as a slight variation can alter the final valuation result.
In this section only the expected flows and the residual present value are discounted to the corresponding weighted average cost, thus obtaining the present value of investments.
Una vez realizada la valoración de una empresa benchmarking is carried out with similar companies to see if it makes sense or if an imputation needs to be revised, or if it serves as a "sanity check".
In addition, it is important to identify what the expected value creation is and the horizon over which it could continue to create value, how sustainable it is and which threats need to be further monitored.
A sensitivity analysis in this section usually provides a great deal of value in terms of knowing what can happen according to the different scenarios previously considered, giving greater certainty about the valuation.
Finally, it is important to be able to justify on what strategy underpins this planned value creation and to try to guide managers to maximise this creation.