Empowering CEOs & CFOs with Automated Business Intelligence | Enabling Business Leaders Worldwide to compound their Impact & Influence with Strategic Finance Tools, Talks and Education | Top Linkedin Content Creator
Are Your Cash Flows Relevant? Capital budgeting (CAPEX) projects may generate cash flows over several periods of time, but the trick is to only evaluate the relevant & incremental cash flows in your decision. ➡️ What cash flows are relevant? Those cash flows that are unique for each separate capital budgeting decision and that will actually change in the future. ➡️ What cash flows are incremental? Those changes in cash inflows and outflows which are directly attributable to investing in the project. ➡️ Here are the 4 types of cash flows you need to evaluate in any capital budgeting project: 1️⃣ Initial investment ✔️Capital expenditures - CAPEX ✔️Opportunity costs - benefits given up if an asset is used for one project instead of another ✔️Tax benefits from the acquisition of capital assets 2️⃣ After tax operating cash flows ✔️ Incremental revenues ✔️ Incremental costs ✔️ Tax effects 3️⃣ Working capital ✔️ Incremental working capital requirements during the project ✔️ Reduction of working capital requirements at the end of the project as receivables are collected, inventory is sold and suppliers are paid 4️⃣ Salvage values ✔️ Proceeds from sales or disposals of assets ✔️ Tax effects 🎯Remember a few important details: ✔️ use an after tax discount rate (WACC) for after tax cash flows ✔️ ignore sunk costs because they're not incremental to the project ✔️ financing costs are already part of the discount rate so don't double count The Excel Net Present Value (NPV) Model for CAPEX investments will go out in the next issue of my free newsletter - The Finance Gem 💎. Subscribe today so you don't miss it. What would you add? ------------------------------------------------ 💎 𝗝𝗼𝗶𝗻 my free newsletter - The Finance Gem 💎 - get my unabbreviated Linkedin post content and other finance gems delivered straight to your inbox >>(𝗹𝗶𝗻𝗸 𝗶𝗻 my Linkedin profile & below in 𝗰𝗼𝗺𝗺𝗲𝗻𝘁𝘀) ➕ Follow me for more finance, business, and cash flow insights. 🔔 Ring the bell at the top right of my profile so you don't miss out on new posts. #entrepreneur #finance #business
Dear Oana, I appreciate the way you breaks down the subject of cash flows, which can be difficult for some people to understand. The explanations and examples you've provided make it easier to grasp the concepts and apply them to capital budgeting decisions Thanks so much for sharing this!
Critical point here: "but the trick is to only evaluate the relevant & incremental cash flows in your decision" I know when I was first learning this it tripped me up a little bit.
Thanks for sharing ma.
Dear Oana, please keep on sharing such posts as it is adding an insight to view it from different different angles and understanding its impact on the FS. Thank you!! Very valuable information you share with us always.
Thanks for sharing Oana Labes, MBA, CPA One element that I always wanted to understand in capital budgeting is the use of what discount rate to what cash flows. In my view, it is not right to use after tax WACC as discount rate and not consider the financing cost in cash flows, thinking it is already part of discount rate, reason below; -Generally, after tax WACC is lower than cost of equity due to lower debt cost and tax shield -And not considering financing cost in cash flow inflates the cash flow Here, we are using higher cash flows and a lower discount rate combination, which inflates the NPV. If we have to assess the same capex decision from equity perspective, then we -discount the free cash flow to equity, after considering the financing cost including debt repayment -And considering cost of equity as discount rate This is opposite combination to above, a lower cash flow and a higher discount rate. Moreover, this may give completely different result. In my view, the second approach is most rigorous test and if NPV is positive here then it’s also positive in first case. If we to use the first approach then we need to additionally subtract the present value of debt to obtain impact on equity. Thoughts are welcome.
Kindly highlight the cash effect details
Well said
Empowering CEOs & CFOs with Automated Business Intelligence | Enabling Business Leaders Worldwide to compound their Impact & Influence with Strategic Finance Tools, Talks and Education | Top Linkedin Content Creator
1yhttps://the-finance-gem.beehiiv.com/subscribe