Cash Flows and Their Relevance
Cash flows refer to both the inflows and outflows of cash during a defined period by a company or corporation and are linked to the business as a whole or a specific capital project. Cash flows measure real economic wealth, take place at particular points in time and are generally free of accounting classification constraints. (Cash Flow, n.d.)
Relevant cash flows have several descriptive factors. A relevant cash flow is one that will change in relation to decisions regarding a project. Relevant cash flows are future flows, not past, and relevant cash flows are measured as the difference in cash flow (to a company/corporation) both with the project and without the project. “These cash flows, called incremental cash flows, represent the change in the firm’s total cash flow that occurs as a direct result of accepting a project”. (e-a) In other words, a relevant cash flow is the after-tax incremental cash flow expected from a proposed project. Other relevant cash flow examples are incremental initial outlay of resources necessary to begin a project (cost of new project) as well as the future salvage value of assets purchased because of a project. Opportunity costs are also considered relevant cash flows due to the use of cash flows that could be generated from currently owned assets being diverted to a new project. Cash flow relevancy is the difference between taking on a new project or not and how that decision affects (or not) the cash flows of an organization. (Intermediate Financial Management Lecture Notes, n.d., The Essentials of Cash Flow, n.d.)
Irrelevant cash flows are costs that are incurred regardless of whether or not an investment in a capital project is made; sunk costs are an example of an irrelevant cash flow.
Capital projects are expected to product cash flows for more than one year. How then, does an organization account for the timing of these cash flows if not from the use of traditional...
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