Enterprise valuation methods – DCF (discounted cash flows) model in FCFF (Free Cash Flow to Firm) and FCFE (Free Cash Flow to Equity) variants
Publication date: June 13, 2025
Cases when valuation of enterprise is required.
What is an enterprise?
The legal definition of an enterprise was introduced on the basis of the Act of 23 April 1964 – Civil Code. According to art. 55 (1), an enterprise is an organized set of intangible and tangible assets intended for conducting business activity. It includes in particular: a designation individualizing the enterprise or its separate parts (name of the enterprise); ownership of real estate or movables, including equipment, materials, goods and products, and other property rights to real estate or movables and others listed in the indicated article. In turn, art. 55 (2) indicates what should be understood by the concept of “legal act involving an enterprise”. According to this regulation: a legal act involving an enterprise includes everything that is part of the enterprise, unless otherwise results from the content of the legal act or from special provisions. As indicated in the literature on the subject: An enterprise as an organizationally connected complex of intangible and tangible assets may be the subject of one legal act (uno actu). The unity of the enterprise is thus presumed, which gives rise to specific rights to the enterprise and all components that were part of the specific enterprise. Additionally, the literature indicates the problem of whether it is permissible for the parties to shape the legal relationship in a different way than through one legal act concerning the enterprise as a whole (in the form of performing several legal acts, which could affect tax optimization). The following position should be indicated here:
The sale of individual components of the enterprise, even if they are of significant value in comparison to the value of the entire enterprise, does not constitute a basis for recognizing that its sale actually took place. The enterprise as the subject of the sale must constitute a whole in organizational and functional terms.
In what situations is a company valuation performed?
A business valuation is required during legal transactions, but also in other circumstances that affect the value of the business. A reliable business valuation may be necessary in the following situations:
- sale, acquisition of an enterprise;
- acquiring investors;
- restructuring;
- submitting the valuation to the tax authorities;
- obtaining financing;
- establishing management plans;
- ownership transformation..
In principle, there is no legal act that precisely specifies the requirements for conducting a business valuation, but there can be found regulations that indicate when a business valuation should be carried out.
One example is Article 319 of the Polish Bankruptcy Law:
1. If the sale of the bankrupt’s enterprise as a whole is planned, when preparing the inventory and estimation of the bankruptcy estate, or separately, if the possibility of such sale is revealed at a later stage, an expert selected by the trustee prepares a description and estimation of the bankrupt’s enterprise. (…)
3. The estimate should separately indicate the value of the enterprise as a whole and its organised parts, if they can be separated for sale.
Regulation on valuation of the enterprise in the event of withdrawal of a partner from a general partnership. According to art. 65 § 1 of the Commercial Companies Code: “In the event of withdrawal of a partner from the company, the value of the capital share of the partner or his heir is determined on the basis of a separate balance sheet, taking into account the sale value of the company’s assets”.
The Commercial Companies Code does not provide a definition of sale value, however, it can be assumed that the balance sheet for the purposes of settlement with the withdrawing partner is a different balance sheet than the one prepared for reporting purposes. As indicated in the literature on the subject, in the case of the regulation of art. 65 of the Commercial Companies Code, one should opt for excluding the application of the income method, such as DCF, and apply the asset valuation method, i.e. the property method. Two arguments are given in favor of this concept:
a/ Article 65 of the Commercial Companies Code indicates that the basis for valuation is to be the balance sheet, not the cash flow statement; the use of the balance sheet is characteristic of the asset valuation method;
b/ Art. 65 of the Commercial Companies Code uses the concept of “sales value” of assets, which is closely related to the asset valuation method (asset method), which consists in correcting the value of assets from their market (sales) value.
As indicated in the studies, this is a unique method for valuing a company.
Other regulations contained in the Commercial Companies Code, relating to the valuation of an enterprise, can also be indicated. These include, for example: Article 175 §1 of the Commercial Companies Code: “If the value of non-cash contributions has been significantly overstated in relation to their sale value on the date of conclusion of the company agreement, the shareholder who made such a contribution and the members of the management board who, knowing this, reported the company to the register, are jointly and severally obliged to compensate the company for the missing value”. Article 266 §3 of the Commercial Companies Code states that: “The shares of the excluded shareholder must be taken over by the partners or third parties. The takeover price is determined by the court based on the actual value on the date of service of the lawsuit”.
It is also worth raising the issue of company liquidation, because in this matter there are also regulations covering a limited liability company and a joint-stock company under the Commercial Companies Code.
The following regulation was adopted for a limited liability company:
Art. 281. [Liquidation balance sheet of the company]
§ 1. The liquidators prepare the opening balance sheet of the liquidation. The liquidators submit this balance sheet to the shareholders’ meeting for approval.
§ 2. After the end of each financial year, liquidators shall submit to the shareholders’ meeting a report on their activities and a financial statement.
§ 3. All assets must be included in the liquidation balance sheet at their sale value.
In turn, the regulation regarding the liquidation of a joint-stock company is presented as follows:
Art. 467. [Liquidation balance sheet of the company]
§ 1. Liquidators should prepare a balance sheet at the opening of the liquidation. The liquidators shall submit this balance sheet to the general meeting for approval.
§ 2. After the end of each financial year, the liquidators shall submit to the general meeting a report on their activities and a financial statement.
§ 3. All assets must be included in the liquidation balance sheet at their sale value.
According to the approach presented in the literature, the method of calculating the balance sheet should take the following form: In the case of a liquidation balance sheet, assets are calculated according to their sale value, not their book value, and the equity capital is not included in the liabilities. The sale value is the real value of an asset that can be obtained on sale. It is therefore the real market value. The opening balance sheet of the liquidation should be combined with an inventory of tangible assets. The liquidators therefore order an inventory of all assets as of the last day of the month in which the liquidation was opened.
The Commercial Companies Code also regulates the share buyout price in connection with a change in the company’s business. According to art. 417 of the Commercial Companies Code: Share buyout shall be carried out at the price traded on the regulated market, according to the average price from the last three months before the adoption of the resolution or, if the shares are not traded on the regulated market, at the price determined by an expert selected by the general meeting. On the other hand, it is indicated that in the case of shares that are traded on the regulated market, the price at which the shares are bought out is the price traded on the regulated market, when the shares are admitted to trading on such market.
On the other hand, if the shares are not traded on the regulated market, the price shall be determined by an expert selected by the general meeting. If no expert is selected at the same meeting at which the resolution was adopted, the registry court should decide on the selection of the expert at the request of the company’s management board.
Another topic worth discussing is the valuation of a company in the event of a merger of companies. According to Article 499§2 of the Polish Commercial Companies Code,the merger plan for capital companies should be accompanied by determination of the value of the assets of the company being acquired or the companies merging by establishing a new company, as of a specific day in the month preceding the submission of an application to announce the merger plan. The declaration in this respect is prepared using the same methods and in the same layout as the last annual balance sheet.
The next act that is important in the subject of enterprise valuation is the Restructuring Law. According to Article 6, Section 3, the term insolvent debtor should be understood as a debtor from the definition of Article 11 of the Bankruptcy Law, i.e. “A debtor who is a legal person or an organizational unit without legal personality, whose separate the act grants legal capacity, is also insolvent when his pecuniary obligations exceed the value of his assets and this state of affairs persists for a period exceeding twenty-four months”.
Therefore, it is particularly important to determine the moment of insolvency, and specifically to determine when the value of monetary liabilities exceeded the value of assets. In such a situation, the market value valuation serves to determine whether and when such a situation occurred. The valuation carried out by the expert also allows to assess whether the premise for declaring bankruptcy of the company has been fulfilled, because the valuation document may show a positive value of equity, despite the negative balance sheet value of this capital.
Sale, merger, acquisition of a company – due diligence
In principle, the process of selling a company should be preceded by a due diligence procedure. It is indicated that the analysis of the company as part of due diligence serves to determine its strengths and weaknesses, as well as the opportunities and threats (risks) that it may pose after the acquisition. The following threats are also indicated: the information advantage of the entity that has previously run the company is a significant risk factor for the other party to the contract (buyer, lessee, etc.). Obtaining information about the company reduces this advantage.
After due diligence, the market value of the company should be assessed. In general, this procedure should include the following steps:
- choice of value standard (usually fair market value or intrinsic value standard),
- adopting the basic assumption of continuing operations or liquidation,
- selection of valuation approach(es) and methods,
- conducting a proper valuation.
As indicated, the basic approach used in terms of the applied valuation method is to choose the DCF method, which will be described below. An alternative method is the comparative approach, based on which the valuation is objectified to the market values of other companies. A difficulty in using this method may be the lack of similar entities or large differences between the selected entities.
Valuation of a joint-stock company (non-public) and a limited liability company
In the case of the valuation of a joint-stock company, no specific regulations regarding the valuation of an enterprise have been introduced, however, based on the individual regulations specified in the Polish Commercial Companies Code, we can indicate which institutions are important from the point of view of the valuation of an enterprise.
First of all, it is necessary to draw attention to the above-mentioned Article 417§1 of the Commercial Companies Code, according to which “the buy-out of shares shall be carried out at the price traded on the regulated market, according to the average price from the last three months before the adoption of the resolution or, if the shares are not traded on the regulated market, at the price determined by an expert selected by the general meeting. If the shareholders do not select an expert at the same general meeting, the management board shall, within one week from the date of the general meeting, apply to the registry court to appoint an expert to value the shares that are the subject of the buy-out”.
An important regulation from the point of view of the discussed subject is also Article 418 (1) § 6 and 7 of the Commercial Companies Code, which provides as follows: the share buy-out price is equal to the value of net assets per share, shown in the financial report for the last financial year, reduced by the amount designated for distribution among the shareholders. Until the day of payment of the entire buy-out sum, minority shareholders retain all rights attached to the shares.
In turn, § 7 of this article stipulates that if a shareholder or company participating in the share buy-back does not agree with the buy-back price specified in § 6, they may apply to the registry court to appoint an auditor to determine their market price or, in the absence thereof, the fair buy-back price.
It should therefore be noted that when buying out shares, it is necessary to have the joint-stock company valued by a certified auditor. The purpose of the valuation is to determine the fair market value of the shares.
In the case of a limited liability company, the previously mentioned Article 266§3 of the Commercial Companies Code concerning the takeover of the shares of an excluded shareholder and the determination by the court of the price of the shares based on the actual value on the day of service of the lawsuit is important.
Investment value of the company
The investment value of an enterprise should be understood as the value of an entity determined from the perspective of a specific buyer, in practice this most often happens in the circumstances of mergers and acquisitions by other entities. Most often, this phrase should be defined as the maximum price that the buyer could pay for the acquired entity.
Within the National Valuation Standard, investment value is defined as: “the value of the valuation object expressed in money or its appropriate equivalent for a specific investor (owner), the estimation of which takes into account his individual requirements and expectations regarding the valuation object. Fair market value, unlike investment value, is depersonalized and impartial.”
National Valuation Standard
As indicated above, there are basically no normative regulations relating to the issue of preparing a valuation. Despite this, it can be indicated that there have been established standards that affect the effectiveness and work ethics of people involved in business valuation. In Poland, there is a National Specialist Valuation Standard “General principles of business valuation”, which is recommended for the Association of Certified Business Valuators in Poland. This standard covers issues such as principles of ethics, basic principles of business valuation, objectives and functions of business valuation, subject of valuation, basic assumptions of valuation and other issues.
Valuation Method
According to the Common National Valuation Principles, the valuation of an enterprise is understood as an ordered activity or process of reaching an opinion on the value of an enterprise, an organized part of an enterprise or shares in its equity. The DCF valuation method is also known as discounted cash flows. In this approach, the value of the asset being valued is determined by discounting the expected cash flows that it generates at a discount rate reflecting its risk. This method is the most well-known and recognized method of valuing an enterprise. The cash flow forecast is based on a plan for shaping the future value of net sales revenues. The sales forecast is the most important element of the free cash flow forecast. In this method, a discounting process is carried out, as part of which the discount rate is obtained. This method uses the time value of money approach. This approach is based on the belief that a given amount of money is worth more on the day of calculation than in a year from that day. Investing in assets with a similar level of risk can bring profits, and such profit is called the discount rate.
The DCF method has several variants, namely:
• FCFE (cash flow method for owners of capital),
• APV (adjusted present value method),
• WACC (weighted average cost of capital method),
• TCF (total cash flow method),
• FCFF (flow method for the enterprise as a whole).
Below, the FCFE and FCFF variants will be discussed in more detail. Among the differences between the FCFF and FCFE variants, we can distinguish a different approach to debt, which affects the different approach to risk. In the FCFF, risk is measured by the WACC rate, while in the FCFE variant, risk is defined by the cost of equity rate..
FCFF variant (full-company cash flow method)
FCFF are cash flows representing the providers of equity and debt (interest-bearing) capital. In the FCFF valuation model, the forecasted FCFF and residual value are discounted (updated with WACC – weighted average cost of capital).
The company valuation process using the DCF method in the FCFF variant takes place in 8 stages:
- estimation of free cash flows attributable to the financing parties for individual years in the detailed forecast period;
- determining the discount rate constituting the weighted average cost of capital;
- estimating the present value of free cash flows attributable to creditors and owners over the detailed forecast period by discounting them at the discount rate;
- estimating the value of the company resulting from the activities after the detailed forecast period, using the residual value estimation methodology;
- estimation of current residual value;
- summing up the obtained values of discounted free cash flows for individual years of the detailed forecast and the discounted residual value;
- increasing the value obtained by non-operating assets;
- reducing the value obtained by the value of liabilities that go beyond the company’s operating activities[1].
The formula that will allow for calculating the company valuation using the DCF method in the FCFF variant has been shaped as follows:
Where:
WP – enterprise value
PV – present value,
FCFFₜ – free cash flow in period t,
PV(FCFFₜ) – present value of free cash flow in period t,
n – number of years of the detailed forecast period,
WR – residual value,
PV(WR) – present residual value,
ANO – market value of non-operating assets (not included in free cash flow),
Zob – market value of interest-bearing liabilities.
Source[2]
However, the time value of the weighted average cost of capital (WACC) must also be taken into account. With this component taken into account, the final formula is as follows:
Source[3]
FCFE (Cash Flow to Equity Method) Variant
It should be noted that FCFE are cash flows to equity providers. In the FCFE valuation model, the forecasted FCFE and residual value are discounted (updated at the cost of equity).
To value the company indicated in the indicated model one should:
- estimate free cash flows attributable to owners for individual years in the detailed forecast period;
- determine the discount rate, which is the cost of equity capital;
- estimate the value of current free cash flows to owners over the detailed forecast period by discounting them at the discount rate;
- estimate the value of the company resulting from the activities after the detailed forecast period by discounting them at the discount rate;
- estimate the current residual value;
- sum up the obtained values: discounted free cash flows for individual years of the detailed forecast and the discounted residual value;
- increase the obtained value by so-called non-operating assets.
The formula for preparing a company valuation in the presented variant is as follows:
Where:
WP – enterprise value
PV – present value,
FCFEₜ – free cash flow to owners in period t,
PV(FCFEₜ) – present value of free cash flow to owners in period t,
n – number of years of the detailed forecast period,
WR – residual value,
PV(WR) – present residual value,
ANO – market value of non-operating assets (not included in free cash flow),
kₑ – cost of equity (expressed on an annual basis),
q – average annual growth rate of free cash flow to owners after the detailed forecast period.
Source[4]
Conclusion
Above, two variants of company valuation in the DCF model have been presented. The analysis indicated the basic features of FCFF and FCFE and the method of company valuation based on these methods, together with the consideration of mathematical formulas that allow for the precise calculation of the necessary values. This method can be used, for example, during the analysis of investment projects. This method of company valuation involves estimating and discounting cash flows in order to determine their current value.
[1] https://xn--wycena-przedsibiorstwa-74c.pl/2023/06/07/wzor-na-wycene-dcf/#Procedura_wyceny_przedsiebiorstwa_metoda_DCF_w_wariancie_FCFF [access: 10/06/2025].
[2]Ibidem.
[3]Ibidem.
[4] https://xn--wycena-przedsibiorstwa-74c.pl/2023/06/15/wycena-dcf/ [access: 10/06/2025].
