Here is a detailed paragraph-style explanation of the following key topics related to Project Cash Flow:
What is Project Cash Flow
Basic Principles of Cash Flow Estimation
Cash Flow Estimation – Time Interval 1 (TI1)
A Live Example for better understanding
---
? What is Project Cash Flow?
Project cash flow refers to the inflow and outflow of cash associated with a project over its lifetime. It is one of the most critical aspects of financial planning and investment analysis. Project cash flows include initial investments (outflows), recurring operational revenues (inflows), operational expenses (outflows), working capital adjustments, and salvage value (final inflow). An accurate estimation of project cash flows is essential for evaluating the financial viability, profitability, and risk associated with any capital project. These cash flows form the basis for applying techniques like Net Present Value (NPV), Internal Rate of Return (IRR), and Payback Period in capital budgeting.
---
? Basic Principles of Cash Flow Estimation
There are a few important principles to follow when estimating project cash flows:
1. Incremental Cash Flows:
Only include additional cash flows generated directly by the project. Ignore sunk costs or unrelated business revenues.
2. Consistency:
Match the type of cash flow (real vs nominal) with the discount rate used.
3. Post-Tax Cash Flows:
Always consider cash flows after tax, as taxes significantly impact real profitability.
4. Exclude Financing Costs:
Interest payments and dividends should not be included in the cash flow estimation—they are considered in the discount rate or financing decision.
5. Consider Timing:
Cash flows must be assigned to the correct year or period (e.g., Year 0 for initial investment, Year 1 for the first full year of operation).
6. Working Capital Adjustments:
Include additional cash tied up in inventory, receivables, or released later in the project’s life.
---
? Basic Cash Flow Estimation – Time Interval 1 (TI1)
TI1 refers to the first full year of operation after the project has been implemented (i.e., after initial setup in Year 0). It is the first year where operational revenues and operating costs begin to occur.
Components of Cash Flow at TI1:
1. Operating Revenue:
Total revenue expected from product sales or services provided in the first year.
2. Operating Expenses:
These include all costs directly associated with production such as:
Raw materials
Labour
Utilities
Maintenance
Administrative overheads
3. Depreciation:
Though it's a non-cash expense, depreciation is used to calculate tax liability.
4. Earnings Before Tax (EBT):
Operating profit minus depreciation.
5. Tax:
Calculated on EBT.
6. Net Profit After Tax (NPAT):
EBT – Tax
7. Add back Depreciation:
Since it's non-cash, it's added back to compute actual cash flow.
8. Working Capital Changes:
Any increase (cash outflow) or decrease (cash inflow) in working capital.
---
? Live Example: Project Cash Flow for TI1
Let’s assume a company is launching a small manufacturing unit for LED lights. The setup occurs in Year 0, and operations begin in Year 1 (TI1).
Initial Investment (Year 0): ₹10,00,000
Expected Sales Revenue in Year 1: ₹7,50,000
Operating Expenses: ₹4,00,000
Depreciation on machinery (₹5,00,000 over 5 years): ₹1,00,000
So, in Time Interval 1, the project is expected to generate ₹2,25,000 as net cash flow after taxes and working capital adjustments.
---
✅ Conclusion
Cash flow estimation is the foundation of every sound investment decision. Accurate projections in Time Interval 1 (TI1) set the tone for further yearly evaluations. Following consistent principles ensures you estimate realistic, reliable, and financially sound projections. It helps investors and management decide whether to proceed, delay, or reject a project. Tools like Excel, financial models, and feasibility reports are often used to project and track these cash flows.
