BACK TO THE FUTURE! THE DISCOUNTED CASH FLOW MODEL IN VALUATION

Written by Jared Tonks, CPA, ABV, CFF^*

It has been somewhat taboo throughout some California courts to use a Discounted Cash Flow model to value a business. Wait: what is the Discounted Cash Flow Model? It is a business valuation method which uses projected future earnings to determine the present value of a business.

Okay, that’s still a little bit too complex. Let’s break it down even further: you buy a business in the hopes that it will make money in the future. A seller will sell a business knowing he/she is giving up the money he/she will make in the future. The amount the seller is willing to take and the amount the buyer pays for the business is dependent upon how much money a business will make in the future.

Let’s assume for a moment we have Company A owned by a husband and wife which they started during marriage—undisputedly community property. Due to irreconcilable differences, the parties decide to file for divorce. Company A is a very successful clothing design and wholesale business where Wife manages the day-to-day affairs. Wife desires to buy out Husband from Company A in 2022. Husband is successful in his own right as an engineer but knows he will be losing the economic benefit (income) associated with the community property business. Husband and Wife each hire a valuation expert and they both go to work.