Discover the process of Discounted Cash Flow (DCF) modeling, a valuation method used to estimate a company's value based on its expected future cash flows, through a step-by-step guide and key considerations.
DCF Model overview and steps
Discounted cash flow (DCF) is a valuation method used to estimate the value of the company based on its expected future cash flows. DCF analysis attempts to figure out the value of the company today, based on projections of how much money it will generate in the future.
Step 1. Derive historical information from financial statements.
The first step in any financial model is to derive necessary information from financial statements. We need to create historical data in the spreadsheet with the model. Then we need to calculate the necessary totals. And after—we calculate Free Cash Flows, which is the gross free cash flow generated by a company.
Step 2. Calculate Historical Value Drivers
Next, we need to create a list of historical value drivers to use in our model and calculate them based on the historical line items above.
Step 3. Make Assumptions for the Projected Value Drivers
We can use historical data for that and also any helpful information in the MD&A and footnotes sections of the 10-K. Also, you can do additional research for the industry to make sure your assumptions make sense.
Step 4. Calculate Projected Line Items for the Model.
Calculating based on historical data and projected value drivers we did input and calculated in the previous step.
Step 5. Calculate Equity Value per Share
The final step and final goal of DCF modeling is to find equity value per share. 
In the Upcoming Videos, We’ll Build This Simple DCF Model Step by Step.
Some of the points that you need to remember:
- There are limitations in terms of using DCF. Primarily that it relies on estimations of future cash flows. That could prove to be inaccurate.
- At the same time, DCF is a simple and effective way to value the company.