NJ Business Valuation Accountant Explains Mid-Year Conventions
I'm going to talk about mid-year conventions. What is a mid-year convention?
When you are valuing a company, typically what you do is you take the cash flows and you take them out five years and then you'll discount them back in order to get what's called the net present value.
Now the one thing is that if you're just discounting those cash flows back, you're assuming that all the cash comes in at the end of the year.
So for example, in year one you're assuming the cash comes December 31st of that year. But that's not how most businesses operate, is it?
Most businesses don't get all their money on the last day of the year. They get it evenly though the year. And that's why you'd have to use what's called a mid-year convention.
So, if you're using the discounted cash flow method, take a look at this mid-year convention because what that does, it assumes half the cash comes in the beginning of the year and half comes in the end of the year.
And of course, there are businesses that do receive a lot of their money at the end of the year like retail. There's some that receive them mostly in the middle of the year like summer businesses and there's some like snow-related businesses that it's in the beginning of the year.
So, you have to think about the discounted cash flow and put more thought into it to say when is that cash flow coming in and match up your discount. And a lot of times you're going to end up using the mid-year convention like we did.
If you have any questions concerning this, please feel free to email me.Return to Video Gallery