Mid-Year Convention

Standard discounting assumes each year's cash flow arrives on the last day of the year. In reality, most businesses earn cash throughout the year. The mid-year convention reflects this by discounting each year's cash flow by half a year less.

For example, with a 10% discount rate, a cash flow at the end of year one is multiplied by a discount factor of about 0.909. Under the mid-year convention, it is treated as arriving at six months and multiplied by about 0.953. A year-two cash flow is discounted for 1.5 years instead of two, using a factor of about 0.867 instead of 0.826.

Because each cash flow is discounted for a shorter period, the mid-year convention produces a slightly higher valuation than end-of-year discounting, often a few percent higher.

The convention is commonly used in professional valuations, particularly for businesses with steady cash flows throughout the year. It is less appropriate for businesses whose cash arrives mainly at specific times, such as seasonal businesses or projects with large payments at the end of each period.