Intra-year Cash Flow Patterns: A Simple Solution for an Unnecessary Appraisal Error

By C. Donald Wiggins (Professor of Accounting and Finance, the University of North Florida),
B. Perry Woodside (Associate Professor of Finance, the College of Charleston), and
Dilip D. Kare (Associate Professor of Accounting and Finance, the University of North Florida)
The Journal of Real Estate Appraisal and Economics
Winter 1991


Heritage Capital Group, Jacksonville, Florida. The appraisal and academic communities have spent much time and effort in recent years developing and refining appraisal techniques to make them as theoretically correct and practically applicable as possible. As a result, income appraisal techniques such as discounted cash flow and capitalization of earnings are commonly used in the appraisal of income producing real property and closely held businesses. These techniques are theoretically sound and have become the primary valuation methods for many appraisers.
However, the high degree of difficulty of forecasting future revenues, expenses, profits and cash flows result in some unavoidable application problems. Actual results almost always deviate from forecasts to some degree because of unforeseeable events and conditions, changing relationships between costs and revenues, changes in government policy and other factors. Many of these problems are unavoidable and the appraiser’s task is to limit errors as much as possible through analysis.
Whatever their theoretical soundness, there is one error built into most appraisal tools as they are commonly applied. This error concerns the intra-year timing of cash flows and returns. Appraisal techniques such as capitalization of earnings, Ellwood formulae and discounted cash flow as they are most often applied inherently assume that income or cash flows occur at the end of each year. This is obviously not realistic in the vast majority of cases. The resulting appraised values may be significantly in error because of this technical assumption implicit in the business valuation tool. The appraisal process is difficult enough without having known errors built in an appraisal technique especially if the errors are significant. This article discusses the problem and proposes a simple solution.

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