What Time Period Should Be Used for Business Valuation? 3 or 5 Years?

When a business is valued, the question often arises: How far back should we look? Should we take the last three years because they are the most current? Or five years to see longer-term trends?

This is not just an academic question. The choice of time period affects the resulting business value and can determine whether the company appears to be a stable enterprise or one experiencing wild fluctuations. Today we will look at how these two options apply to the DCF (Discounted Cash Flow) and CNI (Capitalized Net Income) valuation methods and when it makes sense to use one or the other.

Contents

• Why Do We Care About Historical Data?
• Using the Last 3 Years: Advantages and Disadvantages
• Looking at the Last 5 Years: Advantages and Disadvantages
• What Do the DCF and CNI Valuation Methods Say?
  • DCF Method (Discounted Cash Flow)
  • CNI Method (Capitalized Net Income)
• So Which Period Should You Choose?
• Conclusion

Why Do We Care About Historical Data?

Imagine you are buying a car. You do not just want to know how it looks today, but also whether it was in the shop last year, whether it has any hidden defects, or whether its performance has been declining over time. It is similar with businesses.

Historical financial data tells us:

• How the company has performed over time.
• How it reacted to changes in the economy or its industry.
• Whether its profits have been growing steadily or alternating between periods of growth and decline.

The question is: How many years back should we go to get the most accurate picture?

Using the Last 3 Years: Advantages and Disadvantages

+ More current view of the company

A three-year time series reflects the current situation well. If the company is growing, older five-year data may distort reality. For example, a startup that had high costs and minimal revenue in its first two years would look less attractive under a five-year view than it actually is.

+ Less data, faster analysis

Processing three years of data is simpler than five. Fewer numbers, fewer complications. For quick valuations or internal decision-making, a shorter time series can be advantageous.

- Can distort results

If the company had an exceptionally good period over the last three years, this may lead to overvaluation. Conversely, if it had a one-off decline due to a crisis or pandemic, it will appear worse than it actually is.

- Long-term trends are not visible

For example, in cyclical industries such as construction or the automotive sector, trends manifest over longer periods. If we only take three years, we may overlook broader context.

Looking at the Last 5 Years: Advantages and Disadvantages

+ Provides a more stable picture of the company

A five-year series reduces the impact of one-off fluctuations. If the company had an extraordinary profit or loss in one year, the five-year average will show a more balanced view than a three-year perspective.

+ Better suited for established companies

For companies that have been operating for decades and are not exposed to rapid market changes, a five-year series is ideal. For example, a family-owned food business will likely have stable results, and a longer time series will reveal its true value.

- May include outdated data

If the company has dramatically changed its business model in recent years, older data may no longer be relevant. For example, a traditional retail company that has transitioned to online sales will look different than it did five years ago.

- More complex analysis

More data means more numbers to evaluate. This can be more demanding to process and interpret.

What Do the DCF and CNI Valuation Methods Say?

DCF Method (Discounted Cash Flow)

DCF is based on estimating future free cash flow and discounting it to present value.

• Using a 3-year series: We have more current information, which is an advantage if the company is growing rapidly. The disadvantage is that the model may be less stable.
• Using a 5-year series: We obtain a more balanced basis for predictions, but older data may be less relevant.

Recommendation: If the company has undergone significant changes, a 3-year series works better. If the company is stable and has been operating long-term, it is worth using 5 years.

CNI Method (Capitalized Net Income)

CNI works with average income and a capitalization factor.

• Using a 3-year series: The calculation is faster, but the result may be affected by short-term fluctuations.
• Using a 5-year series: The capitalization factor is more stable, but older data may distort reality.

Recommendation: If the company does not have significant fluctuations, use 5 years. If it is changing rapidly, a 3-year series will be more accurate.

So Which Period Should You Choose?

Three years is better if:

• The company is growing or changing significantly.
• You need a quick analysis.
• It involves startups and dynamic industries.

Five years is better if:

• The company is stable and has been operating long-term.
• You need a more accurate capitalization factor.
• You want to capture cyclical trends.

Conclusion

There is no universal correct answer. It always depends on the context -- the company, the industry, and the purpose of the valuation. If you are unsure, it is worth trying both options and comparing the results.

If you have any questions, do not hesitate to schedule a non-binding meeting with Josef Krejci, our business valuation specialist.