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Improve Your Cash flow: Discounted cash flow

by Robert McCallion and Alan Warner

Discounted Cash Flow (DCF) is a technique that supports decisions to invest in projects that will provide long-term benefit. It is by far the most valid technique though it is relatively complex compared to other more simple methods, for instance the Payback technique which asks the key question – how long before we get our money back?
Instead DCF requires the investor to state how much cash will be generated over the period of the project, probably five or ten years depending on the nature of the investment. The future cash flows are then converted into their present values by calculations based on likely future interest rates; the more rates are likely to rise in the future, the more it will cost to wait and the less the future cash flows will be worth.
In days gone by, the analyst had to work out these numbers with a calculator but these days it is all done by Excel spreadsheets. You put in the future cash flows and out comes the complete calculation of the present values. If the net result is positive, the investment is value creating; if it is negative, value is being destroyed and the project should be rejected.
Does this produce perfect decisions? The answer is no, because all depends on the quality of the assumptions about the future cash flows. As with any analysis of this kind, it is rubbish in, rubbish out!


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Improve Your Cash Flow: Teach Yourself

Improve Your Cash Flow: Teach Yourself
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