Assessing cash flow

In modern methods of profitability assessment, cash flows are more meaningful than profits, which tend to be rather loosely defined. The net annual cash flow after tax is given by... 

As the design progresses, more information is accumulated. The best methods of assessing the profitability of alternatives are based on projections of the cash flows during the project life. ... 

The relationships among the various annual costs given by Eqs. (9-1) through (9-9) are illustrated diagrammaticaUy in Fig. 9-1. The top half of the diagram shows the tools of the accountant the bottom half, those of the engineer. The net annual cash flow Acp, which excludes any provision for balance-sheet depreciation Abd, is used in two of the more modern methods of profitability assessment the net-present-value (NPV) method and the discounted-cash-flow-rate-of-return (DCFRR) method. In both methods, depreciation is inherently taken care of by calculations which include capital recoveiy. 

The ways of assessing profitabihty to be considered in this section are (1) discounted-cash-flow rate of return (DCFRR), (2) net present value (NPV) based on a particiilar discount rate, (3) eqmvalent maximum investment period (EMIP), (4) interest-recovery period (IRP), and (5) discounted breakeven point (DEEP). 

It is not normally possible to make a comprehensive assessment of profitabihty with a single number. The shape of the cumulative-cashflow and cumulative-discounted-cash-flow curves both before and after the breakeven point is an impoiTant factor. 

No single value for a profitability estimate should be accepted without further consideration. An inteUigent consideration of the cumula-tive-cash-flow and cumulative-discounted-cash-flow curves such as those shown in Fig. 9-10, together with experience and good judgment, is the best way of assessing the financial merit of aprojec t. 

Equations (9-59), (9-60), (9-61), and (9-62) may be used as they stand to assess expenditure on energy-conservation measures since a constant amount of energy is saved in each year subsequent to the capital outlay. However, the annual cash flows Acf corresponding to the energy savings remain constant only if there is no inflation or if the money values are corrected to their purchasing power at the time of the capital expenditure. 

Numerical Measures of Risk Without risk and the reward for successfully accepting risk, there would be no business activity. In estimating the probabilities of attaining various levels of net present value (NPV) and discounted-cash-flow rate of return (DCFRR), there was a spread in the possible values of (NPV) and (DCFRR). A number of methods have been suggested for assessing risks and rewards to be expected from projects. 

The method of allocating overheads can seriously affect the assigned costs of a project and hence the apparent cash flows for that project . Since these cash flows are used to assess profitability by the net-present-value (NPV) and discounted-cash-flow-rate-of-return (DCFRR) methods, unfair allocation of overhead costs can result in a wrong choice between alternative projec ts. 

Now that you have determined the likely savings in terms of annual process and waste-treatment operating costs associated with each option, consider the necessary investment required to implement each option. Investment can be assessed by looking at the payback period for each option that is, the time taken for a project to recover its financial outlay. A more detailed investment analysis may involve an assessment of the internal rate of return (IRR) and net present value (NPV) of the investment based on discounted cash flows. An analysis of investment risk allows you to rank the options identified. 

Expenditure on corrosion prevention is an investment and appropriate accountancy techniques should be used to assess the true cost of any scheme. The main methods used to appraise investment projects are payback, annual rate of return and discounted cash flow (DCF). The last mentioned is the most appropriate technique since it is based on the principle that money has a time value. This means that a given sum of money available now is worth more than an equivalent sum at some future data, the difference in value depending on the rate of interest earned (discount rate) and the time interval. A full description of DCF is beyond the scope of this section, but this method of accounting can make a periodic maintenance scheme more attractive than if the time value of money were not considered. The concept is illustrated in general terms by considering a sum of money P invested at an... 

Since the QA/QC laboratory is concerned with the quality of the firm s products, it can influence product costs and revenues (the cash flow associated with the products). It determines acceptance or rejection of raw materials and feedstocks and assesses their market value for the purchasing department. It frequently initiates the processing of claims against vendors providing raw materials which are below grade specification but are nevertheless used. The lab also may be responsible for process monitoring to determine process parameters which minimize the production of scrap or off-grade product. 

Three methods are used to assess the value of a capital investment. They are cash payback, net present value, and internal rate of return (also known as Discounted Cash Flow-Rate of Return). 

The discounted cash flow (DCF) method, to be described here, does enable the making of a fair comparison between inputs and outputs, and provides both an effective rate of return and an easy means of assessing the effects of different approximations. 

Altogether, a comprehensive assessment of the necessary time - taking into account the foreseeable cash flow earmarked to the programme - to attain a stabilized situation is necessary. It may well justify the creation of dedicated intermediate storage facilities for spent fuel (for instance one in the North-West area and one in the Pacific area). 

It is, of course, worse from a business point of view when the cessation of revenues is precipitous and unforeseen as happens when drugs are withdrawn, or licenses rescinded. Some drugs are withdrawn for idiosyncratic responses, which is the most intractable intellectual problem in risk assessment. The cash-flow reverses whenever litigation occurs, even when there is no fault of the drug company. ... 

On the other hand, since chemical products are differentiated by their performance specification, a new product will be governed by its own supply and demand equilibrium, and there will be no guarantee that a new chemical product can be sold at any price. There is no point in trying to calculate the return on investments (a cash flow transient) if the business proposition is not profitable in the steady state, i.e., with investments ignored. Hence before a prospective manufactmer considers whether the investment is justified by its return, ongoing profitability must be assessed first. This is typically a calculation of the market size that must be achieved for revenue to cover fixed costs, a situation referred to as break-even . [15]... 

In profitability assessments, annual cash flows are more meaningful than net profit. The net annual cash flow after taxes (CFxt) is the net profit after taxes less the annual expenditure of capital for additions and modifications. Net annual cash flows are used in discounted cash flow calculations to determine the NPV and the rate of return, which are two key measures used in economic decision analysis. 

Established pharmaceutical firms do fired almost all of their investment needs, not just R D, with internal cash flows from current operations (285). Internal funds may carry a lower cost of capital for complex investments like R D, because outside investors are at a disadvantage in being able to assess the potential returns on R D projects and will therefore demand a higher expected return on their money to cover the risk of being misled by company managers (170,189). The more complex the R D, the more these information disparities are likely to raise the cost of external sources of capital. 

How does the cost of capital affect decisions to invest in R D projects To assess whether the investment is worth its 10 million R D cost, company managers (on behalf of their investors) would compute the net present value (NPV) of the investment by converting all future expected cash flows (both into and out of the firm) into their present value at the time the investment decision is made using the cost of capital appropriate to the project as the discount rate." The algebraic sum of the present values of all the expected cash flows is the NPV of the investment. If the NPV is greater than zero, the investment is worth it and will compensate investors at a rate of return that exceeds the cost of capital. 

The influence of different factors subject to uncertainty can be assessed by a sensitivity analysis. The most probable values are attributed to the base case. Then alternatives are generated by allowing errors in each factor, as for example variations in prices for raw materials, products or utilities, or different interest rates. The discounted cash flow analysis can determine which are the cost elements having the strongest influence on the NPV and DCFRR, and which are unimportant. This type of analysis is relatively simple to be done with a spreadsheet. The formulation of the problem in term of ratios can bring useful insights. 

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