Transforming Projects into Superior Investment Strategies Using Cash Flow Statement Analysis

Abstract

Every project is fundamentally made up of cash flows. An investor may rent a factory, buy raw materials, hire workers, manufacture a product or fund an advertising campaign, all with the purpose of selling a product or service to make a profit. Every part of the project or investment opportunity results in a combination of positive and negative cash flows. Investment opportunities are assessed by estimating and valuing the cash flows that a project will generate. An optimal investment decision balances project returns against project risks and seeks the maximum return per unit risk.

Cash flow statement analysis is a vital skill required to identify superior investment opportunities and to transform mediocre projects into superior investment strategies. They help the active project manager boost returns and eliminate risks, identifying project strengths to harness and weaknesses to prune.

Firstly we review and explain the key items on cash flow statements. Secondly we show how to compute a project’s free cash flows. Thirdly we discuss how to evaluate the cost of capital and project risk. Fourthly we outline how to calculate the Net Present Value (NPV) of a project and discuss optimal investment criteria. We conclude with a case study and perform a detailed project valuation using cash flow statement analysis. An Excel example workbook is provided with this paper.

Keywords: Project Finance, Cash Flow Statements, Working Capital, Cost of Capital, Evaluating Risk, Net Present Value, Optimal Investments, Superior Investment Strategies

JEL Classification: F16, F37, F38, G11, G31, G32