Financial projections and the valuation assumptions built on top of them are what turn a business plan into a dollar figure. The projections forecast revenue, expenses, and cash flow across a three-to-five-year horizon; the assumptions (discount rate, terminal growth, market share, private-company adjustments) decide how those future numbers translate into what the company is worth today. Change the assumptions and the same projections can produce valuations that differ by millions.
What the Projections Have to Contain
Valuation models pull from three linked statements built under Generally Accepted Accounting Principles: the income statement, the balance sheet, and the cash flow statement. GAAP is the framework that makes the numbers comparable and verifiable.1Financial Accounting Foundation. What is GAAP
The income statement drives most of the value. Revenue minus cost of goods, minus operating expenses, produces EBITDA (earnings before interest, taxes, depreciation, and amortization), which strips out financing and accounting choices to show how the core business performs. Investors focus on EBITDA because it lets them compare companies with different capital structures.
The balance sheet shows what the company owns and owes at a point in time. Projected assets, liabilities, and shareholder equity have to reflect depreciation of long-lived assets across the forecast period, since that erosion affects book value and the tax deductions moving through the income statement.
The cash flow statement tracks actual money in and out, split among operating, investing, and financing activities. This is where paper profit meets reality. A company can report healthy income while running out of cash if receivables stall or capital spending drains reserves, and the cash flow line is what valuation models rely on for the free cash flow that gets discounted.
The Assumptions That Move the Number Most
Discount Rate and WACC
The discount rate is the single most influential input. It represents the minimum return investors require given the risk of this business over a safer alternative. Most valuations use the Weighted Average Cost of Capital, which blends the cost of equity (what shareholders expect to earn) with the after-tax cost of debt (what lenders charge). The equity piece usually comes from the Capital Asset Pricing Model: a risk-free rate, plus a market risk premium, adjusted by a beta reflecting how volatile the company is relative to the market.
The risk-free rate is typically anchored to the 10-year U.S. Treasury yield, which has been running in the 4.2% to 4.4% range through early-to-mid 2026.2Federal Reserve Economic Data (FRED). Market Yield on U.S. Treasury Securities at 10-Year Constant Maturity, Quoted on an Investment Basis Every fraction of a point added to the discount rate compresses the present value of future earnings. A high-risk business might carry a WACC of 15% or more, which aggressively shrinks cash flows projected five years out.
Terminal Growth Rate
You can’t forecast individual years forever, so a terminal growth rate stands in for everything after the explicit projection period. It typically tracks long-term GDP growth or inflation, landing around 2% to 3% for most U.S. companies. Under the Gordon Growth Model, the terminal value often accounts for the majority of a company’s total estimated worth, so a small change in this rate produces an outsized swing in the answer.
One hard guardrail: the terminal rate cannot exceed the long-term growth rate of the overall economy. A 5% terminal rate would imply the company eventually grows larger than the economy that contains it. Anything above 3% needs a documented reason.
Revenue Ceiling: TAM, SAM, and SOM
Revenue projections need a credible upper bound, and the TAM/SAM/SOM framework provides it. Total Addressable Market is the full demand for the category. Serviceable Addressable Market narrows it to what your distribution model and geography can reach. Serviceable Obtainable Market narrows it again to the share you can realistically capture given resources and competition. The discipline is in the narrowing. A $50 billion TAM is easy to claim; what supports a valuation is a SOM grounded in actual customer data and competitive positioning.
Where the Underlying Data Comes From
Assumptions have to be checkable. For publicly traded competitors, the SEC’s EDGAR database provides free access to 10-K and 10-Q filings that disclose margins, R&D spending, risk factors, and segment breakdowns.3Investor.gov. How to Read a 10-K/10-Q Private companies don’t file publicly, but industry benchmark reports organized by NAICS codes, the Census Bureau’s standard classification system for U.S. business establishments, let you test whether a projected gross margin or customer acquisition cost is realistic.4U.S. Census Bureau. North American Industry Classification System (NAICS) Internally, three years of federal tax returns (Form 1120 for C corporations) alongside general ledgers and management reports reveal your compound growth rate, expense ratios, and seasonal patterns.5Internal Revenue Service. About Form 1120 – U.S. Corporation Income Tax Return Comparing prior budgets against actual results exposes recurring blind spots that would otherwise carry forward.
How the Assumptions Turn Into a Valuation
Discounted Cash Flow
A DCF converts each year of projected free cash flow into today’s dollars using the WACC, then adds the discounted terminal value. The sum is the enterprise value. Because terminal value usually dominates the total, the model is only as sound as the discount rate and terminal growth rate feeding it.
Comparable Company Multiples
A comparable company analysis (trading comps) works from the other direction. Instead of building up from cash flows, you look at what the market pays for similar businesses. If public software companies trade at ten times EBITDA, applying that multiple to a target’s projected fifth-year EBITDA yields a market-derived value. Comps work best as a reality check against the DCF. When the two methods diverge sharply, something in the assumptions needs revisiting. Analysts often weight both, sometimes equally, to reach a final range.
From Enterprise Value to Equity Value
Enterprise value is the total value of the operating business. To get equity value, add the company’s cash and subtract outstanding debt. In fundraising, this is the pre-money valuation. Adding the new investment produces the post-money valuation, which sets the investor’s ownership percentage. A $2 million investment into an $8 million pre-money valuation gives a $10 million post-money and a 20% stake. That fraction anchors every term sheet.
Adjustments That Apply to Private Companies
A raw DCF or comps output assumes shares trade freely on a public market and that the buyer gets meaningful control. Neither holds for most private transactions, so valuations apply adjustments.
The Discount for Lack of Marketability (DLOM) reflects the reality that private shares can’t be sold on an exchange. A shareholder who wants out may need months or years to find a buyer, and that illiquidity has a measurable cost. Studies of restricted stock and pre-IPO pricing put DLOMs commonly in the 15% to 30% range, depending on expected time to liquidity, dividend policy, and ownership concentration.
The Discount for Lack of Control (DLOC) applies when the interest being valued is a minority stake with no influence over management, dividends, or exit timing. A control premium runs the other way, added when the interest carries the power to direct the company. These adjustments can shift a valuation by 20% or more, so whether the number is on a controlling or non-controlling basis matters as much as the number itself.
Stress-Testing the Assumptions
Sensitivity Analysis
Sensitivity analysis isolates one variable at a time and measures how it flows through to the final valuation. The variables that matter most in a DCF are revenue growth, operating margin, the discount rate, and the terminal rate or exit multiple. A sensitivity table might show that raising the discount rate from 12% to 14% drops enterprise value by 25%. That kind of output tells you which assumptions carry the most weight and where diligence should concentrate.
Scenario Analysis
Scenario analysis moves several variables together to model different versions of the future. The standard framework has three cases. The base case reflects the most likely outcome. The bull case assumes favorable conditions: faster adoption, better margins, a supportive economy. The bear case models real setbacks like losing a key customer, a recession, or margin compression from new competition.
The bear case is where projections earn credibility. A model that shows only upside signals either naivety or dishonesty. Working through a downturn scenario, and identifying the levers available to manage it (cutting discretionary spending, delaying a hire, renegotiating supplier terms), is what investors look for. The spread between bear and bull valuations also indicates the overall risk profile of the investment.
A Boundary on 409A Valuations
Founders searching for guidance on projections and valuation assumptions often assume the same exercise covers stock option pricing. It doesn’t, quite. Private companies issuing stock options must establish fair market value for their common stock under Section 409A of the Internal Revenue Code, and the consequences of failing 409A fall on employees: all deferred compensation becomes immediately taxable, plus an additional 20% tax on that compensation, plus interest at the underpayment rate plus one percentage point going back to when the compensation was first deferred.6Office of the Law Revision Counsel. 26 USC 409A – Inclusion in Gross Income of Deferred Compensation Under Nonqualified Deferred Compensation Plans
Treasury regulations provide a safe harbor when the valuation is performed by a qualified independent appraiser no more than 12 months before the relevant transaction, such as the option grant date, and the safe harbor expires sooner if a material event occurs, like closing a new funding round or entering acquisition talks.7eCFR. 26 CFR 1.409A-1 – Definitions and Covered Plans Most private companies commission a fresh 409A valuation at least annually and after any significant change in the business. Professional appraisals typically run $1,500 to $10,000 depending on capital structure complexity. The three methods used mirror general valuation practice: the income approach (discounting projected cash flows), the market approach (comparing to similar companies or transactions), and the cost approach (restating net asset value). Appraisers usually apply more than one and weight the results by how much reliable data supports each. So the projections and assumptions discussed above feed 409A work, but the format, timing, and independence requirements are additional layers on top.