Finance profit calculation

Where CF is the cash flow from operation, HR is the hurdle rate or required minimum return and II is the initial investment. Advantages of NPV are that it accounts for the time-value of money, provides a value estimate for the lifetime of the project (10 years) and can always be calculated (unlike IRR). Hurdle rates are set by central finance groups or, in some cases, the project team. If a positive NPV is obtained at a given hurdle rate a project is considered profitable and should be executed based on competing priorities. 

It is important for firms to project their cash flow. This ensures that they will have funds on hand to pay their bills and their payroll and to invest in new projects. Cash flow is watched carefully by the finance department, because it is possible for a firm to make a profit on paper and still go broke because they do not have the cash needed to pay bills. When a firm invests in a new plant or new equipment, someone estimates the cash flow to calculate how the investment will influence the firm s ability to pay bills and dividends. In the example above the expenses were shown only as fixed or variable and the calculation was not concerned with the time period in which the expenses had to be paid. Likewise, the sales revenue was calculated on a per unit basis, but the sales may come at different time periods and some of the money for the sales may not be collected immediately. Based on historical records and contracts with suppliers and customers, the firm estimates its cash flow over the relevant time period. The cash flow analysis is shown in Table 3.1 for the example above. The cash flow analysis provides new information that the break-even analysis did not provide. It uses the period-by-period forecast to estimate when the firm will receive money and when it will pay out money. For the first seven months of the project the firm will have negative cash flow of 56,000. Then as sales pick up it will alternate positive and negative cash flows. Part of the reason for this is that revenue will be received 30 days after the product is sold, but the expenses to produce the product will be paid the month earlier. 

Profit is often the key consideration in designing a chemical process. Process economics is the formalism for calculating the finances of making and selling a product. Process economics also applies to the finances of providing a service. The concept of process economics is straightforward. The accounting, however, can be complicated. However, with this complication comes the opportunity for creativity. The economist John Maynard Keynes (1883-1946) remarked, The avoidance of taxes is the only intellectual pursuit that still carries any reward. ... 

Bond SA is planning to manufacture a new product with an initial sales forecast of 3,600 units in the first year at a selling price of 800 each. The finance department has calculated that the variable cost for each truck will be 300. The fixed costs for the manufacturing facility for the year are 1,500,000. Using the information provided by the sales forecast and the finance department it is now possible to calculate the planned profit, the contribution and the break-even point for this venture by leveraging the nature of fixed and variable costs. 

Profitability ratios are used to measure managements effectiveness in generating returns on sales and return on stockholder financing. Information from the income statement is used to calculate these ratios and they are typically represented as percentages. 

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