Cash Flow, Investment, and Financial Forecasting, Explained

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Cash Flow, Investment, and Financial Forecasting

Project Management · Chapter 4: Financial Planning and Cost ManagementSection 4.5 · lesson 29 of 7311 min · free with a free account

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Earn 3 college credits for Project ManagementRecommended for credit by NCCRS · Business 230 · self-paced · one payment, lifetime access
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In this lesson

Cash flow timing, discounting, and investment measures for project decisions.

  • Distinguish cost, profit, and cash flow, and find a project's funding gap from cumulative cash flow
  • Calculate present value and net present value at a stated discount rate
  • Interpret the profitability index, internal rate of return, payback, and simple return
  • Use rolling forecasts, scenario analysis, and sensitivity analysis to keep investment estimates current

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Transcript

Everything said in the video, section by section (1,398 words). Read along, or search it.

Opening Question

Is a Fifty-Six Thousand Dollar Gain Worth It

A library is weighing a heat-pump system. It pays eighty thousand dollars now. Savings arrive over the next four years. Over those years, the money back exceeds the money out by fifty-six thousand. So is it worth doing? Not so fast. It matters when the money moves, how much cash must be found before the savings arrive, and what money later is worth today.

Key Terms

Cost, Profit, and Cash Flow

Three words get confused. Cost is the value of resources used, counted when the work is done. Profit is value earned minus the cost of earning it. Cash flow is the actual movement of money in and out, counted when it moves. Net cash flow for a period is inflows minus outflows. A firm finishes 20,000 dollars of work in month one, at a cost of 12,000 that it pays at once. The customer pays in month three. Month one profit: plus 8,000. Month one net cash flow: minus 12,000. A project profitable on paper can run out of cash.

Cumulative Cash Flow

Finding the Heat Pump Funding Gap

Add each period's net cash flow to the running total, and you get cumulative cash flow. Its lowest point is the funding gap: the most cash the organization must supply before the project pays for itself. The heat pump: year zero, minus 80,000. Year one: 6,000 of early savings, 8,000 of commissioning and running costs: minus 2,000. Years two to four: 52,000 in, 6,000 out, so plus 46,000 each year. Cumulative: minus 80, minus 82, minus 36, plus 10, plus 56 thousand. The funding gap is 82,000, at the end of year one, not the 80,000 price. The total crosses zero during year three, at 2 plus 36 over 46: about 2.78 years.

Time Value of Money

Why a Dollar Today Is Worth More

A dollar today is worth more than a dollar in three years. Money in hand can earn a return, rising prices erode what later money buys, and a promised payment may not arrive. That's the time value of money. To compare amounts at different dates, convert them to a common date using a discount rate: the required return the organization chooses. It may reflect the cost of funds, the project's risk, and policy. It's a choice, not a fact, so results get tested at more than one rate.

Present Value

Discount Factors Shrink With Distance

Present value is the value today of an amount paid later: the future amount divided by one plus the rate, raised to the number of periods. Ten thousand dollars in three years, at 8 percent: 1.08 cubed is 1.2597. Ten thousand divided by that is about 7,938 dollars. One over 1.2597 is 0.7938: the discount factor for year three at 8 percent. Multiply any year-three amount by it. The factor shrinks with distance and with a higher rate, which is why distant benefits count for less.

Net Present Value

Heat Pump NPV at Eight Percent

Net present value is the sum of the present values of the net cash flows, with year zero left undiscounted. Above zero, the investment beats the required return. At 8 percent, the factors are 1, 0.9259, 0.8573, 0.7938 and 0.7350. Present values: minus 80,000, minus 1,852, plus 39,436, plus 36,515, plus 33,810. The NPV is about 27,900 dollars at 8 percent: comfortably positive. In discounted terms, the money comes back only in year four, at about 3.17 years, later than the undiscounted 2.78. NPV's limits: it depends on the chosen rate and on uncertain cash flow estimates, it measures only money, and a big NPV may tie up far more funds than a smaller project.

Quick Check

Present Value of a Future Grant

Quick check. A grant will pay five thousand dollars in two years. At a ten percent discount rate, what is it worth today? Four thousand, forty-one thirty-two, or forty-five forty-five? Pause, and decide. Four thousand one hundred thirty-two. One point one squared is one point two one, and five thousand divided by one point two one is about forty-one thirty-two. Forty-five forty-five discounts only one year. Four thousand subtracts ten percent twice from the face value, which isn't how compounding works.

Profitability Index and IRR

Value per Dollar and Break-Even Rate

The profitability index is the present value of future net cash flows divided by the initial investment: value created per dollar invested. For the heat pump: 107,909 over 80,000 is 1.35. Above one means the same as a positive NPV, and it helps rank projects when funds are limited. The internal rate of return is the discount rate that makes NPV exactly zero. Find it by trial: at 19 percent the NPV is plus 1,039; at 20 percent, minus 918. So the IRR is about 19.5 percent. Compare it with a hurdle rate, the minimum acceptable return. Above a hurdle of 12 percent, it passes.

Cautions

When IRR and NPV Disagree

Two cautions. If cash flows change sign more than once, like a big site-restoration cost in the final year, there may be several IRRs, or none. And IRR can rank options differently from NPV. Option P costs 10,000 and returns 13,000 a year later: an IRR of 30 percent. Option Q costs 100,000 and returns 120,000: 20 percent. At a 10 percent rate, P's NPV is 1,818 and Q's is 9,091. If only one can be chosen and both are affordable, IRR favors P, and NPV favors Q. Which should rule is disputed. NPV states value in money, and adds across projects. IRR is a percentage people grasp easily, with no rate fixed in advance. Whether to maximize total value or hit a target return is a question of values.

Screening Measures

Payback and Simple Return Ignore Timing

Payback and simple return on investment are screening measures: quick, easy to explain, and blind to timing. Payback ignores what happens after recovery. Simple return divides total net benefit by total cost. For the heat pump: 162,000 in, 106,000 out: 56,000 net, a 52.8 percent simple return. That figure wouldn't change if every benefit arrived a year later. NPV would fall. So use screening measures for a first look, and discounted ones when timing matters.

Rolling Forecasts

Actuals Replace Forecasts Each Period

Forecasts must stay current. A rolling forecast is updated on a set cadence: actuals replace forecasts, assumptions are revised, and the horizon extends by one period. At the end of month four, a forecast covers months five to seven. At the end of month five, month five's actual replaces its forecast, and month eight is added. Say month five was forecast at 14,000 but came in at 16,500. And a supplier delay moves a 5,000 payment from month six to seven. The new forecast shows both. That keeps the funding gap estimate current, so a cash shortfall shows up in time to arrange funds.

Scenarios and Sensitivity

Testing the NPV Under Changed Inputs

Scenario analysis recalculates under a few consistent sets of assumptions, like optimistic, base and pessimistic, changing several inputs together. Sensitivity analysis changes one input at a time, holding the rest fixed, to see which moves the result most. The heat pump's base-case NPV is about 27,900. With inflows in years 2 to 4 cut 10 percent, about 15,500. Investment 10 percent higher: about 19,900. A 12 percent rate: about 16,900. Optimistic, with inflows 10 percent higher: about 40,300. Pessimistic, lower inflows and higher investment together: about 7,500. Positive in every case, so the answer doesn't hang on one hopeful assumption. And the inflow estimate moves it most. Simulation, with many random draws, comes later in the course.

Quick Check

Locating the Fleet-Charging IRR

Quick check. A fleet-charging upgrade has an NPV of plus 23,200 at 5 percent, plus 1,600 at 10 percent, and minus 5,800 at 12 percent. Where does its internal rate of return lie? Pause, and decide. Between ten and twelve percent. The NPV is still positive at ten and negative at twelve, so it crosses zero in between: about ten point four percent. And the answer hinges on the rate. A committee that hasn't settled one should see the NPV across the range, not a single figure.

Benefits Tracking

Planned Versus Actual Benefits by Period

Finally, an approved investment promises benefits, so track them against the money spent, using the same periods as the case. For each period, keep the planned benefit, the actual benefit and the difference, plus the cumulative position, and update the NPV if the pattern changes. That keeps the case honest during delivery, and warns early if benefits come slower than assumed. The formal review after delivery comes later in the course.

Key Takeaways

Cash Flow, Discounting, and Testing

To recap. Cash flow is not profit: watch the cumulative curve, and size funding by its lowest point. Discount future money to compare it fairly: present value and NPV, at a stated rate. Use the profitability index to rank under limited funds, and IRR with care against a hurdle rate. And test the answer with scenarios and sensitivity, and keep forecasts rolling.

About Project Management at UPI Study

Project Management (Business 230) is a self-paced online course of 73 video lessons in 12 chapters, from starting and defining a project to planning, budgets, scheduling tools, proposals, contracts, execution, monitoring, closure, teams and certification. It carries a NCCRS credit recommendation for 3 semester credits.

Every lesson transcript is free on pages like this one, and the videos are free with a free UPI Study account. Enrolling adds a practice quiz after each lesson, the graded work and final exam that earn the credit, lifetime access, and an official transcript on completion. UPI Study has helped over 130,000 students with college credits. ACE and NCCRS have over 2,100 cooperating colleges that will consider accepting credits; the final decision is with the universities.

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Why take it here

Why students take Project Management with UPI Study

How projects are planned, run and closedProject Management teaches how to deliver work on time and on budget: scope, schedules, the critical path, budgets and earned value, risk, contracts, monitoring and closing a project, and leading the team. It is a common course in business, management and engineering degrees.
Credit at a fraction of the priceThe same 3 credits can cost $750 or more at a US college. Here it is one payment, self-paced, with lifetime access.
Finish your degree soonerTransfer credits reduce the courses you still owe, so you can graduate earlier or lighten a heavy semester.
Strengthen an applicationA completed college-level course on an official transcript shows admissions and scholarship committees you can do the work.
Study on your own scheduleNo start dates, no deadlines. Watch the lessons, practice, and take the final when you are ready.
130,000+students helped with college creditsACE and NCCRS have over 2,100 cooperating colleges that will consider accepting credits; the final decision is with the universities.

Where the credit goes

Universities that work with NCCRS

Project Management carries a NCCRS credit recommendation. These universities work with NCCRS; some are UPI Study's signed partners. ACE and NCCRS have over 2,100 cooperating colleges that will consider accepting credits; the final decision is with the universities.

Thomas Edison State UniversityThomas Edison State UniversitySigned partnerUniversity of the PeopleUniversity of the PeopleSigned partnerCharter Oak State CollegeCharter Oak State CollegeSigned partnerStrayer UniversityStrayer UniversitySigned partnerColumbia Southern UniversityColumbia Southern UniversitySigned partnerIndiana TechIndiana TechSigned partnerPenn StatePenn StateWorks with NCCRSSouthern New Hampshire UniversitySouthern New Hampshire UniversityWorks with NCCRSSUNYSUNYWorks with NCCRS +many more cooperating universitiesFind my college →

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FAQ

Questions students ask us

About Cash Flow, Investment, and Financial Forecasting

What is the difference between cash flow and profit on a project?
Profit is value earned minus the cost of earning it, while cash flow is the actual movement of money in and out, counted when it moves. A firm that finishes $20,000 of work in month one, pays $12,000 of costs at once, and is paid in month three shows an $8,000 profit but a negative $12,000 cash flow that month. A profitable project can still run out of cash.
How do you find the funding gap from a project's cumulative cash flow?
The funding gap is the lowest point of the cumulative cash flow, the most cash the organization must supply before the project pays for itself. A heat pump costing $80,000 with a net outflow of $2,000 in year one reaches minus $82,000 before net savings arrive. So the funding gap is $82,000, not the $80,000 purchase price.
How do you calculate net present value for a project?
Net present value is the sum of each period's net cash flow divided by one plus the discount rate raised to the number of periods, with year zero left undiscounted. For example, $10,000 received in three years at 8 percent is worth about $7,938 today, because 1.08 cubed is about 1.2597. A positive NPV means the investment beats the required return at that rate.
Why can IRR and NPV rank two projects differently?
IRR measures a percentage return, while NPV measures value in money, so a small project can have the higher IRR and the lower NPV. Spending $10,000 to get $13,000 a year later gives a 30 percent IRR, and spending $100,000 to get $120,000 gives 20 percent. At a 10 percent rate, though, their NPVs are about $1,818 and $9,091, so NPV favors the larger project.

About the Project Management course

How many college credits is Project Management?
Project Management (Business 230) carries a NCCRS credit recommendation for 3 semester credits. ACE and NCCRS have over 2,100 cooperating colleges that will consider accepting credits; the final decision is with the universities.
How much does Project Management cost and what is included?
$250, paid once, with lifetime access: all 73 video lessons, a practice quiz after each, the graded work and final exam, and an official transcript when you finish. Students who want several courses choose UPI Study PRO instead.
Which universities accept UPI Study credits?
UPI Study has signed partner agreements with universities such as Thomas Edison State University, University of the People and Charter Oak State College, and works with universities such as Penn State, SNHU and SUNY. ACE and NCCRS have over 2,100 cooperating colleges that will consider accepting credits; the final decision is with the universities. Use "Find my college" on this page to check yours.
How long does Project Management take?
It is self-paced with no deadlines. The 73 lessons total about 15 hours of video; most students add reading and practice time and finish in a few weeks to a few months, on their own schedule.
How are the exams done?
Quizzes and assignments are online in the course. The final exam is taken online with proctoring; a person on the UPI Study team checks assignments, usually within two days.
How do my credits reach my college?
When the course shows 100% complete, request the official transcript from your dashboard. It is sent to the college you name, and you can send it to more than one. Check your college first with "Find my college" on this page, or ask Athena.

Ready for the full course? Earn 3 credits in Project Management.

73 video lessons, a quiz after each one, and the graded work that earns the credit. Recommended for credit by NCCRS.

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