A DCF dated inside the financial year, worked line by line, and what the two common shortcuts cost.
When the valuation date falls inside a financial year, value only the cash flow still to come in that year, the stub, discount it over the fraction of the year that remains, and shift every later period by the same fraction. For an illustrative company valued at 30 September with a December year end, the stub is 0.25 of a year, its cash flow is $3.6 million of the year's $12.0 million, and the enterprise value is $207.6 million. Counting the full year's cash flow instead overstates it by $8.2 million, or 4.0 per cent.
Worked in full in Business Valuation by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A forecast is built in financial years, but transactions and fairness opinions are dated whenever they happen. Between the valuation date and the next year end lies a partial period, the stub. Two things must be adjusted for it. The cash flow: part of the current year's free cash flow has already been earned and sits in the balance sheet, as cash or as lower debt, so it is already in the net debt deducted to reach equity value. And the timing: every forecast cash flow is now closer than a whole number of years, so each discount period shortens by the part of the year already gone.
The company and its forecast are fictional. The valuation date is 30 September 2026 and the financial year ends on 31 December, so the stub is three months, 0.25 of a year. Unlevered free cash flow for 2026 is forecast at $12.0 million, of which 30.0 per cent, $3.6 million, falls in the fourth quarter; the business is seasonal, so the stub share is taken from the quarterly budget rather than prorated. The cost of capital is 9.5 per cent and terminal growth 2.5 per cent.
| Period | Free cash flow | Discount period (years) | Discount factor | Present value |
|---|---|---|---|---|
| Stub, Oct to Dec 2026 | 3.6 | 0.250 | 0.9776 | 3.52 |
| 2027 | 13.0 | 1.250 | 0.8928 | 11.61 |
| 2028 | 14.0 | 2.250 | 0.8153 | 11.41 |
| 2029 | 14.9 | 3.250 | 0.7446 | 11.09 |
| 2030 | 15.7 | 4.250 | 0.6800 | 10.68 |
| 2031 | 16.4 | 5.250 | 0.6210 | 10.18 |
| Terminal value | 240.1 | 5.250 | 0.6210 | 149.1 |
| Enterprise value | 207.6 |
Stub fraction = months to year end / 12 = 3 / 12 = 0.25 (days / 365 where precision matters)
Stub cash flow = full-year forecast × share still to come = 12.0 × 30.0% = 3.6
Discount period for full year n = stub fraction + n, so 2027 is 1.25, 2028 is 2.25 and so on
Terminal value = 16.4 × (1 + 2.5%) / (9.5% − 2.5%) = 240.1, discounted at 5.25 years
Excel, with the valuation date in B1 and the first year end in B2: =YEARFRAC(B1,B2,3) for the stub in B3, then =$B$3+D$4 across the full years, with the year count 1, 2, 3 in row 4, and =CF/(1+WACC)^period for each present value.
The explicit years and the stub add up to $58.5 million, and the terminal value contributes $149.1 million, 71.8 per cent of the total. The $8.4 million of 2026 cash flow earned between January and September is not in the DCF; it is in the 30 September balance sheet, and the net debt figure used in the bridge to equity must be taken at that same date.
A useful check: value the company at 31 December, when the stub has been received, and discount back. At the year end the remaining cash flows are worth $208.8 million. Discounted over three months at a factor of 1.0229 that is $204.1 million, plus the $3.52 million present value of the stub, which returns the same $207.6 million.
| Treatment | Enterprise value | Error | Error |
|---|---|---|---|
| Full-year 2026 cash flow in the stub | 215.8 | 8.2 | 4.0% |
| Stub ignored, 2027 discounted at 1.0 | 208.8 | 1.2 | 0.6% |
| Correct, end-of-period | 207.6 | ||
| Stub right, later years not shifted | 194.2 | −13.4 | −6.5% |
The largest error is the quiet one. Treating the stub as if it were year 1 and starting 2027 at year 2 pushes every cash flow, and the terminal value, nine months too far out, and on a value 71.8 per cent made of terminal value that costs $13.4 million. Including the whole of 2026's cash flow double counts the $8.4 million already earned, once in the DCF and once in the cash on the balance sheet. Ignoring the stub entirely, which values the company as at 31 December, happens to land close because the omitted stub and the omitted three months of discounting partly offset, but it is right only by accident.
On the mid-year convention the stub cash flow is discounted to the middle of the stub, 0.125 years, and each full year to its own middle, 0.75, 1.75 and so on. With the Gordon terminal value discounted half a year earlier to match, the value rises to $217.1 million. The mechanics of that convention are in how much the mid-year convention adds to a DCF.
| Valuation date | Stub (years) | Stub cash flow | Correct EV | Full-year error | Error |
|---|---|---|---|---|---|
| 31 March | 0.750 | 9.6 | 204.0 | 2.2 | 1.1% |
| 30 June | 0.500 | 6.6 | 205.8 | 5.2 | 2.5% |
| 30 September | 0.250 | 3.6 | 207.6 | 8.2 | 4.0% |
| 30 November | 0.083 | 1.2 | 208.4 | 10.7 | 5.1% |
The correct value drifts up through the year, as it should: the company is worth more as the future cash flows come closer, offset by the cash already received. The double count grows the other way, because the later the date, the more of the year's cash flow is already in the balance sheet. A deal signed in late November with an unadjusted model overstates value by 5.1 per cent.
A stub period needs two adjustments that must be made together: only the cash flow still to come, and discount periods shortened by the part of the year gone. Here that gives $207.6 million, with errors of plus 4.0 and minus 6.5 per cent for the two common shortcuts. The free cash flow build and the terminal value block for the book's own company are in the free workbook for this case, and the cash flow definition in how to calculate unlevered free cash flow.
It is the partial period between the valuation date and the next financial year end. Only the cash flow still to be earned in it is included, discounted over the fraction of the year that remains. In the worked case, at 30 September, the stub is 0.25 years and carries 3.6 million of the year's 12.0 million of free cash flow.
Add the stub fraction to each whole year: with a 0.25-year stub, the first full year is discounted at 1.25 years, the second at 2.25, and a terminal value after five years at 5.25. Leaving the full years at 2, 3 and so on understates the illustrative company's value by 13.4 million, or 6.5 per cent.
It does if the full-year cash flow is used, because the part already earned is in the balance sheet cash or net debt at the valuation date. In the worked case 8.4 million of the year's cash flow was earned before 30 September, and counting it again overstates enterprise value by 8.2 million.
This article is one calculation from Business Valuation. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
Get the book on Amazon →Free companion files
Also on Amazon UK · Amazon Germany · Amazon France · Amazon Canada
Reading guide: corporate finance, valuation and markets → · All 1501 articles →
If this book helped, or didn’t, a few lines on Amazon are worth more than they look: they are what the next reader goes on. Write a review. The workbook stays free either way.