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Net present value (NPV) is a concept that involves understanding what is happening for the company in terms of the influx of cash into the business as well as how that cash is spent. The figure basic represents what remains after the present value of the cash flow into the business is reduces by the present value of cash flowing out of the business model. The connection between net present value and cash flows is that without knowing how much is coming in and how much is going out, there is no way to determine the net present value.
In order to have an accurate assessment of the amount of capital available for a project, identifying the current status of net present value and cash flows is essential. The process calls for identifying the current amount of cash that is coming into the business. This can involve cash generated due to capital investments as well as sales. Income from any source is part of the inbound cash flow and is available for use in managing day-to-day operational costs as well as settling any other short-term or long-term debt obligations. Starting the process with a confirmed income figure will set the stage for eventually determining the actual NPV.
Along with identifying the current amount of cash coming into the business, it is also necessary to determine how much of that cash is going out to settle various expenses. This means that with net present value and cash flows, the emphasis is on not only what is received but also what is going out during the period under consideration. All types of disbursements are considered to be part of the process, since presumably all types of expenses are settled out of the income received by the company. By subtracting the outflow of cash from the cash influx for that period, the resulting figure is the net present value.
Failure to identify all relevant data regarding the influx and outgo of cash will adversely effect the whole process involving net present value and cash flows. For example, if the figures for cash outflow are lower than the actual disbursements, this means the net present value that is calculated will be too high. As a result, the business could make decisions that ultimately create some degree of financial hardship. By accurately assessing all type of cash transactions, the information used to determine both net present value and cash flows will result in data that helps business owners in making sound financial decisions for the upcoming period.
What if I have a project for 5 years and the cash flow changes at 2.5 years, at the same annual interest rate. How do I calculate the NPV?
Assuming the cash flow at 2.5 years and from 2.6 to 5 years are the same, but just calculated separately, is this NVP the same as the NVP calculated if the cash flow was same the entire period?