Saturday, October 9, 2010


Developing Cash Flow Estimates

Estimation of cash flows is a difficult task because the future is uncertain. Operating managers with the help of finance executives should develop cash flow estimates. The risk associated with cash flows should also be properly handled and should be taken into account in the decision making process. Estimation of cash flows requires collection and analysis of all qualitative and quantitative data, both financial and non-financial in nature. Large companies would generally have a management information system providing such data.

Executives in practice do not always have clarity about estimating cash flows. A large number of companies do not include additional working capital while estimating the investment project cash flows. A number of companies also mix up financial flows with operating flows. Although companies claim to estimate cash flows on incremental basis, some of them make no adjustment for sale proceeds of existing assets while computing the project’s initial cost. The prevalence of such conceptual confusion has been observed even in the developing countries. For example, in the seventies, a number of UK companies were treating depreciation as cash flows.

In the past, most Indian companies chose an arbitrary period of 5 or 10 years for forecasting cash flows. This was so because companies in India largely depend on government owned financial institutions for financing their projects, and these institutions required 5 to 10 years forecasts of the project cash flows.

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