Cash Flow Calculation - Capital Budgeting

http://mksnotes.blogspot.com 4 comments
Basic principles which should be kept in mind while calculating cash flows are mentioned below.
1. Incremental approach
While calculating cash flows, only those cash flows are considered which can be associated and attributed to adoption of a particular project. Finance manager should check for nature of expenses very wisely while evaluating proposals. Only incremental cash flows are considered for capital budgeting.
2. Financial cash flows 
As cost of debt or equity is already considered in WACC (weighted average cost of capital) which is used for discounting cash flows, financial cash flows are ignored in order to avoid error of double counting,
3. Cash flows are considered on after tax basis. Tax savings is considered as an inflow.
4. Depreciation is added back to PAT as they are of non-cash nature and provides a tax shield i.e. reduction in tax liability. All non-cash items should be added back to PAT to arrive at cash inflows.
5. Sunk cost is ignored as these are not incremental.
Sunk costs are that cost which has already been incurred in past, prior to evaluation of proposals and is thus ignored as this doesn't have effect on present or future decisions. Example, if a company has piece of land acquired in past and is considering to set up a plant on that land, then this cost land acquisition in past is considered as sunk cost.
If a new land has to be acquired for this new project then the cash outflows should be considered in capital budgeting.
6. Opportunity costs are considered as they are sacrificed. Opportunity costs of a resource is its value in its best alternative usage.
7. Unless given otherwise, it is assumed that cash outflows are considered to have occurred in the beginning of the year and inflows to be occurred at the end of the year.
8. While evaluating replacement decision, savings in costs are always considered as inflows and that to on after tax basis.

Calculation 
Cash inflows
PAT (Profit after tax) + Depreciation +Financial charge (1-tax rate) – Capital expenditure (if any) – Repairs (if any)
Where,
PAT is calculated as
Net sales revenue – Cost of goods sold – Selling, general & administration expenses – Depreciation – Interest – Taxes
Where,
Cost of goods sold is calculated as
Opening inventory + Purchases – Closing Inventory

Cash outflows
Cost of new plant + Installation expenses + Other capital expenditure + Additional working capital – Tax benefit on account of capital loss on sale of old plant (if any) – Salvage value of old plant + Tax liability on account of capital gain on sale of plant (if any)



Fig: Showing items which are excluded / included in the calculation of cash flows.

4 comments :

  1. Unknown23 July 2017 at 18:32

    Hi,

    Can I check if we should include the increase in purchase of inventory and also sales and administrative costs in the Capital Budgeting cash flow table?

    Thanks!


    Regards,
    Angelynn

    ReplyDelete
  2. Unknown27 April 2018 at 03:53

    financial tracker calculators

    ReplyDelete
  3. Funding Solutions9 January 2020 at 21:40

    We are one of the most trusted business finance lenders in the industry to offer the best working capital solutions for small businesses. For more information get in touch at Mantis Funding.

    ReplyDelete
  4. Unknown5 April 2020 at 02:46

    I have a question sir
    Why do we use cashflow instead revenue and cost in capital budgeting
    Plz and my question sir

    ReplyDelete

Subscribe to: Post Comments ( Atom )