Many Small Business Owners Do Not Use Discounted Cash Flow

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The Answer is Several important reasons might explain the limited use of DCF techniques, including the following:
• For many owners of small firms, the business is an extension of their lives—that is, business events affect them personally. The same is true in reverse: What happens to the owner personally affects his or her decisions about the firm. The firm and its owner are inseparable. Consequently, nonfinancial variables may play a significant role in an owner's decisions.
• Survival often becomes the top priority when the undercapitalization and liquidity problems of a small business directly affect the decision-making process. Long-term planning, therefore, is not viewed by the owner as a high priority in the total scheme of things.
• The greater uncertainty of cash flows within small firms makes long-term forecasting and planning seem unappealing and even a waste of time. The owner simply has no confidence in his or her ability to predict cash flows beyond two or three years, so calculating the cash flows for the entire life of a project is viewed as a futile effort.
• The value of a closely held firm is less easily observed than that of a publicly traded firm, whose securities are actively traded in the marketplace. Therefore, the owner of a small firm may consider the market-value rule of maximizing net present values irrelevant. Estimating the cost of capital is also much more difficult for a small company than for a large firm.
• The limited size of a small firm's projects may make net present value computations less feasible in a practical sense. The time and expense required to analyze a capital investment are generally the same whether the project is large or small, so it is relatively costlier for a small firm to conduct such a study.
• Financial management talent within a small firm is a scarce resource. The owner-manager frequently has a technical background, as opposed to a business or finance orientation, and his or her perspective is influenced greatly by that background.

Many Small Business Owners Do Not Use Discounted Cash Flow

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