This note reviews the basics of projecting cash flows for a typical operating decision. To find the economic consequences of any decision, one needs to project the cash flow effects of that decision and discount those at the appropriate hurdle rate. The focus on cash flows arises because any evaluation of economic impact must recognize opportunity costs—the other uses to which one might allocate resources available to a firm. This note discusses two typical ways to organize operating information to calculate cash flow, typically referred to as free cash flow in this context. The first estimates the cash consequences related to various elements of a decision. The second starts with a typical accounting estimate of operating income before taxes and then makes adjustments. The concepts in this note are applied to the firm Morgan Industries, a setting that has been integrated across all the Financial Analytics Toolkit series of technical notes.ExcerptUVA-F-1896Rev. Dec. 6, 2019Financial Analytics Toolkit: Cash Flow ProjectionsTo find the economic consequences of any decision, one needs to project the cash flow effects of that decision and discount those at the appropriate hurdle rate. This note reviews the basics of projecting cash flows for a typical operating decision.The focus on cash flows arises because any evaluation of economic impact must recognize opportunity costs—the other uses to which one might allocate resources available to a firm. Since a cash flow received today can be invested, it matters whether a decision generates a cash flow today versus a cash flow in the future. The central challenge with cash flow projections, therefore, is to adjust correctly for items that affect the timing of cash flows: accrual accounting impacts on reported results and tax effects associated with depreciation and amortization.There are two typical ways to organize operating information to calculate cash flow. The first estimates the cash consequences related to various elements of a decision. We will refer to this approach as a calculation of cash flow by parts. The second starts with a typical accounting estimate of operating income before taxes and then makes adjustments. We will refer to this approach as a calculation of free cash flow. In either situation, the resulting cash flow can be referred to as "free cash flow," though this name is more commonly associated with the second approach
