Net cash flows, the difference between cash inflows and cash outflows, can be computed for any kind of business or employment. When analyzing a viable investment opportunity, cash flow is often grouped into three, these are, initial investment cost, operating cash flows, and terminal cash flows. These cash flows accrue during the entire life of a project. On the other hand, businesses categorize their cash flows into three different classes, these are, cash flows from operating activities, cash flows from investing activities, and cash flows from financing activities. Cash flows from operating activities originate from the main activities of a business. The same concept can be used to prepare a cash flow statement associated with holding a job. In this case, the concept of a cash flow statement for a project will be used. The statement will contain initial cash investments incurred by the individual. An example is the education expense. The other category of cash flow is operating expenses. Examples of this category are travel cost, medical expenses, and housing expenses among others. The final category of cash flow will comprises of terminal cash flow. An example is retirement benefits (Shapiro, 2005). The table presented below is a simple cash flow statement for an accountant. It illustrates how to compute cash flows from working. A flat tax rate of 25% is used in the calculations.
|Expenses||Taxes||Cash In/Cash Out ($)||Balance ($)|
|Initial investment cost||-25,000|
|Income Before Taxes||5,760|
|Income After Taxes||3,360.00|
|Membership subscription fees||-550|
|Income after Expenses||770.00|
From the table presented above, the total amount of the net cash flow that the individual earns from employment at the end of each period totals to $2,370.
Payback period = Initial investment / cash flows
= 25,000 / 2,370
= 10 years and 7 months
Based on the calculations above, it can be observed that the accountant will recover his initial investment after working for ten years and seven months.
Capital budgeting considerations
A number of items need to be taken into consideration before carrying out capital budgeting decision making. Such considerations can either be numeric or non – numeric. The first consideration is that a manager needs to discover opportunities. Under this, a manager will focus on finding probable opportunities for the business. This can be in the form of venturing into a new product line, opening a new production plant, and venturing into a new market among others. At this point, the manager needs to generate a list of all the possible opportunities. The second consideration is evaluating the opportunities. Under this, the manager needs to find out which opportunities are consistent with the objectives of the organization. The third considerations will be to estimate the amount of cash flow of the opportunities. A manager may focus on projects that promise a constant cash flow throughout their entire life because cash flows are more significant than accounting profits. A manager should use comprehensive methods to compute realistic amount of cash flow for each opportunity (Hickman, Byrd, & McPherson, 2013). Finally, the manager should consult with other professionals before selecting a project to invest in. Thus, it can be observed that a manager must take into account both quantitative and qualitative considerations before making capital investment decision.
Hickman, K., Byrd, J., & McPherson, M. (2013). Essentials of finance. San Diego, CA: Bridgepoint Education Inc.
Shapiro, C. (2005). Capital budgeting and investment analysis. New Jersey, USA: Pearson Education Publishers.