Determine discount rate: Discounting of future earnings

Definition: What is the discount rate?

You might assume that the value of the company will be infinite, assuming that positive earnings will flow in every year. However, this is not so, because earnings that flow to the buyer at a later point in time are worth less relative to today than earnings that are available immediately. The later the income flows in, the more it is discounted using a discount rate. The nature of this discounting regularly leads to finite income values.

The interest rate to be applied is made up of a risk-free prime rate set by the respective central bank – such as the ECB or the FED – and risk components. The risk components in turn contain a premium for the respective industry risk and a further premium for the specific company. Corporate risk depends on the size, focus and management of the company.

Formulas: How to calculate discounting

The factor by which a future accruing income must be discounted to be comparable to today’s income is the reciprocal of ((1+interest rate) to maturity). The higher the interest rate, the greater the effect of discounting future income. If different returns are expected over the coming years, these individual future returns must be discounted individually using this formula and then added together. Income expected in two years is discounted with a term of “2”, income expected in three years with a term of “3”, etc.

For the period after a foreseeable immediate future, a discounted “perpetuity” is applied, which is added to the discounted future earnings.

Useful tool for calculating the enterprise value

If you would like to perform a business value calculation that incorporates discounting, here is an easy-to-use calculation tool.

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Financial Due Diligence Checklist
Contents In the context of corporate transactions, target companies are systematically assessed. The instrument of due diligence is used for this purpose. One facet of this due diligence is the examination of the financial circumstances of the company in which you are interested. The systematic assessment of these financial aspects is the subject of financial due diligence, for which you will find a structured checklist here.The practical checklist contains 34 questions on purely financial aspects, 8 questions on insurance issues and 6 questions on possible public subsidies.As a prospective buyer, you can write your findings behind each point, use relevant sources of information, refer to annexes, name supporting documents and write your comments. This creates a record of your review as you conduct your financial due diligence. If, following your review, you have the seller sign for his confirmation, you will have a valuable basis for the guarantees to be defined in the purchase contract.This checklist is also valuable for sellers to carefully prepare for a financial due diligence. Go through the points on this checklist carefully and consider how you can find answers to them or what you should still grind in your company from a financial point of view before the sale.This checklist is available in German, English and Spanish so that corporate transactions can be supported across national borders.  Advantages of your Financial Due Diligence ChecklistWith this checklist, you will be made aware of essential relevant audit areas that affect finances. You will receive a practice-oriented checklist for financial due diligence that has an appropriate level of depth. For prospective buyers, the use of this checklist during the financial due diligence creates a solid basis for the seller-side guarantees to be defined in the purchase contract. For sellers, this checklist gives concrete indications of possible questions that prospective buyers will ask. The checklist supports good preparation for the sales process and the associated financial due diligence.Digital Download After ordering, you will receive a download link to the structured checklist which you can use immediately.Please note that this checklist to which you are purchasing access is for your personal use only. It is prohibited to resell the checklist in any form and in any digital or physical manner, or to publish it in any physical or online publication without my permission. I am the sole copyright holder of this file.Link to download: pdf  What is financial due diligence? A due diligence is a systematic recording of all relevant opportunities and constraints that characterise a company or part of a company. Due diligence reviews are used in the course of corporate transactions. They are intended to give the buyer certainty about the transaction object.In a financial due diligence, all financially relevant aspects are examined and recorded.When recording these characteristics, the sources of information are indicated. It is customary for the prospective seller to sign the resulting due diligence protocols, thereby formally confirming his documented statements. In this way, due diligence protocols can be used as a basis for sales guarantees that are formulated in the transaction contract.  Procedure of a financial due diligence review A financial due diligence begins with the recording of all possibilities, restrictions and burdens that a company or part of a company has with regard to its finances. Attention must be paid to the completeness of the information. Concrete formulations are recommended, such as: "The list in Annex x includes all existing continuing obligations. No other continuing obligations exist." Furthermore, attention should be paid to precision. A formulation such as "The planned corporate transaction does not cause any obligation to repay funds from the public subsidies granted, with the exception of ..." How a checklist can help you with financial due diligence In order not to forget any important aspect during the comprehensive financial due diligence, it is advisable to use a suitable checklist. Good checklists are pre-structured and contain the essential aspects that should be included in a financial due diligence.In any case, you do not carry out the financial due diligence arbitrarily with a tried and tested checklist, but ensure a systematic procedure. Instead of having to make fundamental considerations, you can concentrate on the substantive examination. 
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