EBITDA multiple vs discounted cash flow

An EBITDA multiple and discounted cash flow, or DCF, are two of the valuation methods a buyer or seller may see quoted for the same business. They answer the question differently. One takes a single earnings figure and applies a multiple seen in the market. The other builds a forecast of cash flows and converts it into today’s value. The inputs differ, the assumptions differ, and so do the situations in which BDC says each is used. This page compares those points and leaves the choice to a qualified professional.

What an EBITDA multiple is

BDC says market-based approaches calculate a valuation by applying a valuation multiple, which may be based on EBITDA, revenue or other metrics, and that the specific figure varies greatly with factors that include industry, market conditions and the multiples used by comparable businesses. BDC’s valuation glossary describes the market approach as looking at the sales prices of comparable firms that have been recently sold to determine the multiple of earnings that was paid.

• Input: an earnings figure and a multiple drawn from comparable sales.
• Assumption: the comparables resemble the business.
• BDC notes EBITDA does not account for non-operating expenses such as interest on debt, taxes and other costs.

What discounted cash flow is

The CBV Institute defines the Discounted Economic Income Method as a method within the Income Approach in which the present value of expected economic income is calculated using a discount rate. The DCF Method is a form of that method based on cash flow. BDC’s glossary calls DCF the most common equity-based valuation method, which establishes the value of a company using several different operating forecasts.

• Input: forecast cash flows and a discount rate.
• Assumption: the forecast is realistic.
• BDC lists unrealistic assumptions in cash flow or earnings projections among valuation mistakes.

How they differ

BDC says a valuator determines value by reviewing past results and forecast cash flow or earnings, and may also assess how reasonable the projections are. It adds that a buyer is not buying what the business earned in the past but what it will earn in the future, and that historic results provide guidance without being necessarily indicative of future results. A multiple applied to one period of EBITDA leans on market evidence for that conversion. DCF leans on the forecast and the rate. Cash flow is also a different input from EBITDA, which BDC says leaves out interest on debt, taxes and other costs. The EBITDA multiple answer covers the multiple alone.

When BDC says each is used

In its guidance on valuing a company, BDC says discounted cash flow is used when cash flow is expected to fluctuate substantially in future years, such as when a company is growing rapidly, and that capitalized cash flow is used when cash flow is expected to remain stable. BDC also lists inappropriately mixing valuation methods among valuation mistakes, and says valuators generally offer a price range that the company would probably sell for to an arm’s-length party, not one precise value.

Which fits depends on the facts

These factors are conditions to check, not advice on which to rely on.

• If cash flow is expected to fluctuate substantially, BDC points to DCF; if it is expected to remain stable, BDC points to capitalized cash flow.
• If credible projections exist, ask who prepared them and who has assessed whether they are reasonable.
• If recent sales of comparable businesses are available, they can supply a multiple.
• If earnings have not been normalized, or cash-flow items sit outside EBITDA, the figures will not line up.
• If the figure is for a lender, a tax filing or a dispute, ask whether a credentialed valuator is needed.