The Economist Guide to Financial Management by John Tennent

Author:John Tennent
Language: eng
Format: epub
Publisher: Profile
Published: 2013-06-02T16:00:00+00:00

4 Sign convention

In building the cash flow forecasts it is important to be disciplined about the sign convention. The standard convention is that a cash receipt is positive and a cash payment is negative.

FIG 10.3 Cash flow timing

5 Cash flow timing

Most project cash flows are forecast with annual time intervals. The standard layout is shown in Figure 10.3.

Time 0 is the moment the first cash flow takes place. Time 1 is one year after the first cash flow takes place; time 2 is two years after the first cash flow takes place, and so on. Under these assumptions all cash inflows and outflows during any particular year are assumed to take place at either the beginning or the end of the year. With these annual intervals it can be difficult to identify the appropriate point at which to place a cash flow. An overriding principle is to be prudent and if necessary accelerate payments and defer receipts. Therefore the following general rules apply:

Capex. These outflows should be placed at the start of a year. A large capital spend may be spread over the first few years of the project and thus the expenditure in any year would be put at the start of that year.

Revenue. This is typically shown at the end of the year in which it has been received.

Opex. Caution would suggest these costs should be shown at the beginning of the year in which they are paid out, but the principle of matching overrules. Therefore opex costs are normally shown being matched against the revenue they support. By applying this treatment the profit in any year is deferred to the end of the year in which it is earned.

The effect of these prudent timings is to make the project appear marginally less financially attractive than it actually is.

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