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Metrics that can help your cash flow

Metrics that can help your cash flow

If you want to dig into the technical terms and concepts behind modelling results, eg opportunity cost and time value of money, this is the page for you.

Understand your cash flow better

These four results are calculated for you in our modelling workbook. 

Free cash flow

What it is: Free cash flow is the money left after paying expenses that maintain or expand your assets and operations.

Why it’s useful: It’s a good picture of your financial performance. Free cash flow is also the money you can spend on a new project or investment. If you don’t have enough free cash flow to fund it, you can see how much you’ll need from a lender or investor.

To work it out: Our modelling workbook calculates it for you — it’s your operating cash flow minus capital expenditure.

Positive free cash flow shows you have money to spend on repaying loans, paying investors, or on improving your business. Negative free cash flow means you don’t. It’s common to have negative free cash flow when your small business is growing, as you’re spending money now so you can earn more in the future.

Free cash flow = operating cash flow – capital expenditure

Free cash flow = operating cash flow – capital expenditure

Operating cash flow is on your cash flow statement. Capital expenditure is on your balance sheet. Our modelling workbook calculates free cash flow for you.

Modelling workbook

Present value of money (PV)

What it is: How much a future sum of money is worth today, based on interest rates and/or inflation.

If you have money today, it’s worth more now than in the future because you could invest it and earn interest. Or you could spend that money, buying more now than you could in the future because inflation will increase prices.

Why it’s useful: It’s a way to compare the expected performance of projects or investments at a future point by translating it back into today’s money.

To work it out: Our modelling workbook uses a 20% discount rate to bring future money back to the present value. You can edit this figure to see what happens to your results if interest rates rise or fall.

Net present value of money (NPV)

What it is: The total of present values, also called net present value (NPV). It shows today’s total value of your future returns, negative and positive.

It shows the expected performance of a project or investment over time. It’s never 100% accurate because it depends on so many things, eg inflation, interest rates, your estimates of future cash flows.

Why it’s useful: It’s the go/no-go figure when deciding on a new project or investment.

Since you’ll put money in now, with the value of a dollar being what it is today, net present value converts your total expected return into today’s money. This gives a better sense of how your money will grow.

To work it out: Add up each year’s present value — our modelling workbook does this for you. If it’s a positive number, a project is more likely to be worth going ahead with. If it’s negative, it is safer not to go ahead.

Internal rate of return (IRR)

What it is: A percentage that measures how profitable a project needs to be to:

  1. earn you money
  2. pay interest on a loan, or an investor’s expected rate of return
  3. at least match the return you get from an existing income stream.

Why it’s useful: It gives you a good estimate of the percentage return on a project. For example, if your bank pays 5% interest on savings, and the IRR of a potential project is 3%, you are probably better off investing your money in the bank.

If you want investors or lenders to help pay for a project, your expected earnings should make enough profit so you both get a cut.

Here are two examples:

  1. If you’re going to borrow money at 7% interest, the IRR needs to be higher than 7%. If it’s well above this figure, you have wriggle room in case your costs and/or earnings go up or down.
  2. If an investor wants a return of 8%, an IRR of 10% means you can tell them they’ll be happy investing in your project.

For another investor example, see our modelling workbook. It uses sample figures from our tech company case study.

To work it out: It’s the percentage that makes your NPV equal zero. Our modelling workbook calculates it for you, and includes tips on how to tell what’s good and what’s not.

Financial modelling helps you see the benefits and risks of new opportunities.

Financial modelling helps you see the benefits and risks of new opportunities.

The results will help your decision-making.

Financial modelling: Step-by-step guide

Introduction to modelling concepts

It pays to be comfortable with strategic finance before you explore these concepts, which underpin our modelling workbook. These definitions are intended as an introduction only. Talk to your financial advisor or mentor to dig deeper.

Time value of money

Time value of money means what money is worth changes over time.

Any amount is worth more the sooner it’s received. A dollar you invest today is worth more than a dollar you receive tomorrow, because of its potential to grow through interest — or contribute to the growth of your business.

Understanding the time value of money is useful when a business is making decisions about its future. It helps show whether one project will be more lucrative than another, or whether there’s more to gain through investing money in another opportunity.

Getting your head around this helps you work out what your money will be worth in the future — another concept known as future value of money.

Future value of money

Future value of money is the value of an asset at a specific time in the future, based on an assumed rate of growth. This asset could be money invested in a bank or a business, or it could be a piece of equipment.

If $10 invested today is guaranteed to accrue interest at a certain rate and be worth $100 in a year, the future value of $10 in one year is $100.

Related modelling result: Present value
Present value (PV) shows the value of future money today. It’s a line item in our modelling workbook — see steps 2 and 3 in the workbook.

Opportunity cost

Opportunity cost is used when deciding which project or investment to go ahead with.

It’s the difference in return between a chosen option and the next best alternative. Whenever you need to choose only one option, you give up any potential benefits from those you decide against, eg investing with one bank means missing out on the interest rate offered by another.

Related modelling result: Discount rate
A discount rate is used to reduce forecast cash flows back to today’s value. It’s a line item in our modelling workbook — see steps 2 and 3 in the workbook.

Discount rate

A discount rate is like interest in reverse. It’s a percentage that reduces future money back to the present value — that is, today’s money.

Which discount rate to use can vary, depending on the project or investment being modelled. It’s often the growth rate or expected return on another opportunity or potential project, eg interest rate on a savings account, profit margin on an existing product.

If you’re unsure about the accuracy of your forecast figures, use a higher discount rate. A low rate is for lower risk projects, in which projected figures are more certain.

Financial modelling workbook

Financial modelling workbook

See how numbers can help you make big decisions, including those that involve borrowing money or seeking investors.

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