All financial and economic activities of the company are presented as net cash flow, that is, the ratio of income and expenses that are generated by all the work. Making any decisions related to the possibility of investing capital is a rather important step in the work of any modern company, because in order to really effectively use the available funds and get the maximum possible profit from the invested capital, you need to conduct a detailed analysis of cash flows aimed at the implementation of developed plans, projects and operations.
Cash flows are estimated using discount methods, taking into account the concept of the time value of this money.
In this case, the task of the financial manager is the choice of projects, as well as those ways of their implementation, which will allow you to get the maximum possible inflow of funds at the maximum present value in comparison with the number of capital investments needed for this. In other words, the main goal is to ensure maximum net cash flow.
Investment analysis
There are several technologies with which you can evaluate the attractiveness of certain investment projects, and therefore, there are several most important indicators of the effectiveness of cash flows generated by these projects. Each individual technology basically has one principle: in the process of implementing a specific project, the company should make a profit, that is, its own capital should grow. At the same time, there are a lot of indicators that define the project from several sides and correspond to the interests of different people related to it, and one of these indicators is net cash flow.
The first stage from which the analysis of the effectiveness of various investment projects begins is a careful calculation of the capital investments necessary for its implementation, as well as forecasting the possible income from this project.
What is a net cash flow?
The basis for calculating various performance indicators of projected or already used investment projects is net cash flow. It is calculated by determining the difference between the costs and revenues associated with the implementation of this project and determined by the number of monetary units for a certain period of time. In this way, net cash flow can be determined. The formula is as follows:
- Monetary unit / temporary unit.
In the overwhelming majority of cases, capital investment is made at the beginning of the project, that is, at the zero stage or during the first few periods, and only then does the inflow of profit begin.
From a financial point of view, all the streams of current expenses and income, as well as the net cash flow of the project, allow us to fully characterize it.
Forecasting
In the forecasting process, it is highly advisable to forecast the data of the first year, breaking them down by months, while the second year should already be broken down by quarters, and all subsequent ones should have nothing but total annual values. The use of this scheme is recommended by most specialists, but in practice it should fully comply with the conditions of a particular production.
What are they like?
Net cash flow (the calculation formula was described above), which has negative elements preceding positive ones, is usually called standard, while non-standard flow provides for the possibility of alternating negative and positive elements.In the overwhelming majority of cases, such situations can be encountered in practice when it is necessary to allocate a large amount of funds to complete a particular project, it is worth noting that additional financial investments may also be required during the implementation of the project, which are related to environmental protection.
Why are they used?
There are several advantages that distinguish the calculation of net cash flow in the process of evaluating the effectiveness of investment and financial activities of a particular company:
- cash flows always comply with the theory of value of money, which is the basic concept of modern financial management;
- they represent a precisely defined event;
- their use allows you to completely eliminate the problems related to memorial accounting.
What to consider?
When determining the amount of net cash flow, you must take into account absolutely all the flows that change in connection with this decision:
- all changes in income, payments and receipts;
- costs necessary for the implementation of production;
- tax deductions;
- changes in working capital;
- all kinds of costs necessary to use rare resources available to the company.
At the same time, it is worth noting the fact that those cash flows that will not change in connection with this decision should not be taken into account, namely:
- past cash flows;
- costs that would have been incurred in any case, regardless of whether the investment project was implemented or not.
Expenses
There are two types of costs that form the volume of the required capital investments:
- Immediate. They are required to run a specific project. In particular, this includes the construction of buildings, the purchase and installation of specialized equipment, all kinds of investments in working capital and much more.
- Alternative. In the predominant majority of cases, this concerns the cost of the used premises or plots of land that could become profitable in other operations if they did not need to be occupied for the implementation of the project.
Also, predicting the net operating cash flow, one should not forget that the reimbursement of the costs necessary to increase the working capital of the company is carried out after the completion of the project and allows you to increase the cash flow related to the last period.
The final result of each individual period, which allows the formation of future cash flow, is the amount of net profit increased by the amount of accrued depreciation, as well as accrued interest on all borrowed funds. In this case, interest was already taken into account in the process of determining the cost of capital, so they do not need to be re-counted.
Development options
Since the value of net cash flow is forecasted in the face of uncertainty, to take into account the risk factor, three implementation options need to be considered - optimistic, realistic, pessimistic. The smaller the difference in the final financial indicators for each individual option, the more stable this project will be to any changes in external conditions and the less the risk associated with the implementation of this project will be.
Main factors
An important step that must be taken into account when evaluating the net cash flow indicator is the analysis of the current financial capabilities of the company, in the process of which it is necessary to determine the cost of the company's capital for various volumes of necessary investments.
The value of WACC is the basis for making various investment or financial decisions, therefore, in order to increase the capital of a company, it is necessary to make the cost of this capital less than the income received from its investment.
The weighted average cost of capital of WACC in most cases is selected as the discount rate in the process of evaluating any future cash flows. If necessary, it can be adjusted for certain indicators of possible risk related to the implementation of a particular project, as well as the projected inflation rate.
If the WACC calculation is difficult, as a result of which there may be doubts about the reliability of the result, then in this case it will be necessary to choose the average market yield as a discount rate, providing for an adjustment for all kinds of risks that the implementation of the project in question carries.
In certain cases, the value of the discount rate is taken commensurate with the refinancing rate set by the Central Bank.
Payback period
It is necessary to calculate the payback period of allocated investments, first of all, when deciding on the attractiveness of an investment project for a company. It is worth noting that this technology can also be used to reject projects that are unacceptable in terms of liquidity.
Most of all, in the process of calculating this indicator, lenders are interested, for whom the maximum payback rate is one of the guarantees for a full return of the funds provided by them.
The decision criteria in the process of using the technology for calculating the payback period can be formulated in the following ways:
- The project can be accepted if the detected DPP value is within the specified limits. This option is always used in the process of analyzing projects with a fairly high degree of risk.
- A project can be accepted if, on the whole, its payback takes place.
If you are choosing from several projects, then preference is given to those with a shorter payback period, since they can make a profit in the shorter term.
