CASH FLOWS

Cash receipts and cash disbursements are referred to as cash flows. The cash receipts are cash inflows and the cash disbursements are cash outflows.

Capital expenditure is a present commitment of cash to a project in order to reap the benefits in the future. The benefit of a project is the return the project makes for the organization in the form of cash inflows during its life. The project will be worthwhile only if the total cash inflows over its life exceed all the cash outflows. The main aim of the quantitative part of the cost—benefit analysis, used to rank projects for selection purposes, is to compare all expenses and revenue. Therefore, capital investments as well as operating expenses have to be considered as costs; and all income, including the capital return on the disposal of the asset, is considered as revenue. This is achieved by using all the cash inflows and outflows related to the project in the calculations.

Although the cash flows take place continuously, it is customary to treat all those that occur over a specific period as a single cash flow. Generally, this period is one year and the cash inflows and outflows during this period are aggregated as the inflows and outflows for the year. In many instances, a shorter period such a month could be considered for calculating the aggregation of cash flows. This depends on the need of the person or organization performing the analysis. For our purpose, cash flows over a period of a year are taken to explain various concepts throughout this part of the book because this assumption simplifies the calculations. The cash flows would probably occur irregularly during each year. To determine the feasibility of a project, all cash inflows and outflows for a year could be considered to take place either at the end of each year or in the middle of it. In all cash flow calculations we will assume that all cash flows occur at the end of each year.