Estimation of future cash flows is the topic of financial management (MBA). We know it for evaluating a project before investment with capital budgeting. It is the starting point of investment analysis. We need two type of cash flows. One is cash outflow and other is cash inflow. Cash outflow is the cost of project. Cash inflow is total revenue from that project. Suppose, I purchased millions machine. It is the cost of project. Total profit from this project is millions in 5 years. In estimation of future cash flow, we have to estimate whether cost of project is millions or other and we also have to estimate whether total revenue of project is millions or other.
Now, question is how to estimate the future cash flows? So, my aim to write this content is to explain, how to estimate the amounts which I have explained in above examples. Following are its two simple steps:
1st Step Estimation of the Total Cost of Project
For estimating the future value of cash outflow, we have to estimate following cost.
a) Estimating the cost of purchasing the project
First of all, we have to research in market and calculate the cost of purchasing a new project.
b) Estimating additional cost of removal old project
Because, we have to use new project in the same place, so we have to sell old project or remove it from that place. What will be its cost? It will be our capital expenditure and will be include in future cash outflow.
c) Estimating additional cost of installation of new project
This additional cost will pay for installing new project.
d) Estimating the cost of Inflation
Due to increasing the prices, it may be possible when next day, we will go to market for buying fixed asset, its cost may be double. So, inflation cost will be added.
2nd Step : Estimation of the Total Cash Revenue
For calculating total cash revenue, we will estimate total sale from that project. We all know that we buy machine or project for increasing our production or sale. Suppose, machine will use for 10 years, we have to estimate the sale of product produced from that machine in 10 years. We also calculate the cost of revenue expenses. What expenses will we pay in 10 years. It may be machine repair charges and other. After deducting revenue expenses from sale of products, we can calculate cash revenue. For estimating cash inflow, we have to deduct total tax. But we must not deduct depreciation, interest and dividend.
Above steps, you can also learn with following example:
Now, question is how to estimate the future cash flows? So, my aim to write this content is to explain, how to estimate the amounts which I have explained in above examples. Following are its two simple steps:
1st Step Estimation of the Total Cost of Project
For estimating the future value of cash outflow, we have to estimate following cost.
a) Estimating the cost of purchasing the project
First of all, we have to research in market and calculate the cost of purchasing a new project.
b) Estimating additional cost of removal old project
Because, we have to use new project in the same place, so we have to sell old project or remove it from that place. What will be its cost? It will be our capital expenditure and will be include in future cash outflow.
c) Estimating additional cost of installation of new project
This additional cost will pay for installing new project.
d) Estimating the cost of Inflation
Due to increasing the prices, it may be possible when next day, we will go to market for buying fixed asset, its cost may be double. So, inflation cost will be added.
2nd Step : Estimation of the Total Cash Revenue
For calculating total cash revenue, we will estimate total sale from that project. We all know that we buy machine or project for increasing our production or sale. Suppose, machine will use for 10 years, we have to estimate the sale of product produced from that machine in 10 years. We also calculate the cost of revenue expenses. What expenses will we pay in 10 years. It may be machine repair charges and other. After deducting revenue expenses from sale of products, we can calculate cash revenue. For estimating cash inflow, we have to deduct total tax. But we must not deduct depreciation, interest and dividend.
Above steps, you can also learn with following example:
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