Cash flow discounting

The concept of discounting cash flows implies the process of bringing the value of transactions made at different times to a value that is relevant for the present time. For example, for the sale of any enterprise, it is necessary to reassess it, that is, to determine the value taking into account the changing market conditions. The method of discounted cash flows in the implementation of transactions with investments is especially often used. After all, to make an economically profitable investment, you need to take into account any changes in the value of the asset.

It is worth noting that the use of this technique requires the development of a certain level of qualifications and sufficient knowledge. Only a specialist will be able to carefully study each indicator and accurately calculate the current cost of a particular project. The discounting of cash flows has the temporary effect, as the new value quickly loses its relevance, especially at the micro level, when any movement of assets and assets has an impact.

To obtain more accurate and reliable information, the specialist performs calculations in two ways. The first method involves taking into account the time factor, and the second, accordingly, does not take it into account. Discounting of cash flows allows the investor to make a decision about investing funds taking into account the risk factors and the effect of inflation. You can compare the profit received at different time periods. To do this, you should get the difference in the proceeds of the funds and all the costs, discounted with the use of the same interest rate. Thus, net discounted cash flows are obtained.

The accuracy and correctness of the results of the analysis performed depend not only on the data provided, but also on the correct choice of the discount rate. To determine it, one of three popular methods is used: the calculation of the weighted average cost of funds, analysis of assets designed for long-term use, and cumulative construction. The latter method is the most respected among specialists and is used most often. This is explained by the fact that this method takes into account the degree of riskiness of the operation as accurately as possible.

Discounting of cash flows is considered the most reliable method for determining the rationality of investments. Its advantages are not subject to any doubts. But there is a drawback, which is the laboriousness of the process. To get the most accurate and truthful result, you will need considerable time and great patience on the part of the specialist.

In addition, the discounting of cash flows takes into account not only the degree of risk, but also inflation expectations. Accounting for the change in inflation can be achieved by one of two basic methods. According to the first method, the inflation component is taken into account when calculating the discount rate, and in the second variant, each flow is deflated during the accounting. That is, the second method involves the inclusion of inflationary changes immediately.

The method of discounting flows is based on the compilation of a specific model of the company's financial performance. As a rule, such a model is developed on the basis of an analysis of the profit and loss account and documents reflecting the movement of cash and funds on the company's accounts. To obtain free cash flow, it is necessary to reduce the flow of capital from operating activities by the amount of investment. The received amount of funds is considered the income of the organization, some of which goes to settlements with creditors and borrowers, and a part is distributed among all shareholders in the form of dividend payments.

Based on the results of the analysis conducted with the use of discounting, the expert draws a conclusion about the possibility of improving the production process, the appropriateness of involving funds in other projects in order to increase profits in the future.