What Is Initial Cash Flow?
Initial cash flow is the total money that is available when a project or business is in the planning stages. The figure includes any loans or investments made in the project. It is usually a negative figure since launching a business requires capital investment in the hopes of generating future income.
Initial cash flow is factored into the discounted cash flow analysis that is used to evaluate the feasibility of a project.
Initial cash flow can also be called initial investment outlay.
Key Takeaways
- Initial cash flow represents the upfront costs or initial cash outlay involved in starting a new project or purchasing an asset.
- In some projects, salvage proceeds from discontinued ventures may be considered by deducting those gains from the initial cash flow total.
- Due to the high cost of startups, initial cash flow is typically a negative number.
Understanding Initial Cash Flow
During the capital budgeting process, the attractiveness of a project is evaluated based on the cash flows that are expected to be generated by the project over its life, compared to the initial cash flow needed to get it started.
Virtually any new business or business project undergoes this process. If a company is considering building a new factory or expanding into a new market, an analysis of its initial cash flow is undertaken. An investor who is considering bankrolling a new venture will conduct a similar analysis to help decide whether it’s worth the investment.
What Initial Cash Flow Includes
The initial cash flow figure includes all operating and equipment costs for the planning stage.
In some cases, the total may be offset by the salvage value. For instance, if a company is retooling a plant to adapt it for the production of a new product, old equipment no longer needed might be sold off. In such cases, the capital gains tax or loss on the sale is also factored in.
The net proceeds will offset the cash outlay for the project.
Future Value
Using discounted cash flow analysis, the future value of the cash flows over the life of the project is brought back to its present value to help determine whether it is worth the investment.
The initial cash flow is paid in at the start of the project. This number isn’t discounted because it is not a future value but a present one. It is “time zero.”
This analysis is crucial. An error in the cash flow or discount rate estimation can lead a company to undertake an unprofitable project.
Example of Initial Cash Flow Analysis
Say a neighborhood restaurant wants to expand into home meal delivery. The restauranteur must begin by considering the additional supplies needed to pull this off, from cartons and other paper goods to a dedicated phone and a vehicle. There also will be payroll costs for the delivery personnel.
There may be no additional equipment costs since the kitchen is adequate for the expanded service. There are no salvage costs since nothing is being replaced.
Now, how much money does the restauranteur expect to bring in once home delivery is on the menu? The restauranteur can estimate it based on current business activity and knowledge of the local market.
As long as the estimated income is greater than the initial cash flow, the project may be worth pursuing.
Analyzing the Alternatives
In this example, as in many others, the business owner may be wise to conduct additional analyses on the alternatives for a home delivery business. An alliance with DoorDash or UberEats would significantly reduce the restaurant’s initial cash flow number.
However, delivery apps charge both the restaurant and the customer for every order. And that reduces the business cash flow, not just initially but long term.
