The Cash Flow Model and Investment Metrics

 

In the second of my series on Investment Analysis, I continues with the subject of Investment Analysis based on a series of three seminars for the UK Chapter PMI during 2018 and 2019.

Imagine the letter 'J' on a cash flow chart.  This is the curve of cash flow and is the basis of economic evaluation.  There are two parts to the cash flow: the outflow investment – the expense and then the inflow of revenue – the return.

All economic analysis is based the cash flow. Where I worked we had two main economic indicators that were calculated for each project and used as part of the business case.

1. NPV (Net Present Value)- discounted cash flow at a prescribed cost of capital – discount rate.
2. IRR (Rate of Return) – effective interest rate of the cash flows

Let’s take look at the assumptions behind the value calculation.  These are key to understanding the business case, which is only as good as the assumptions that underly it.

What is your favourite sport or TV competition show – is it football, soccer, baseball, basketball, ice hockey, cricket, rugby or strictly come dancing?  What do you look out for?  The SCORE!  Remember that point as I explain Investment Analysis. For you the important thing is the SCORE.

There are 5 key factors to consider – these represent different points on the 'J'  cash flow curve and make up the SCORE.  For each there are key assumptions to be made 

S for Sanction of the Project - the Financial Investment Decision Point right at the start

C for Capital Cost - the outflow expenditure of the project

O for Operating Start-up - the project start-up - end of expense and start of revenue

R for Revenue Stream - the income over an expected project life

E for Endurance of the Asset - the expected project life.

SCORE is a useful acronym because it implies a reference point and a benchmark of the key assumptions which need to be delivered by the Project Plan.

Now with this as the basis of assumptions that affect the elements of SCORE and therefore the cash flow – any variance in these will affect the value of the project.

In the next two blogs I will share stories that illustrate the elements for SCORE that underpin the Investment Analysis.