discounted cash flows

(noun)

A method of valuing a project, company, or asset using the concepts of the time value of money. All future cash flows are estimated and discounted to give their present values (PVs) — the sum of all future cash flows, both incoming and outgoing, is the net present value (NPV), which is taken as the value or price of the cash flows in question.

Related Terms

Examples of discounted cash flows in the following topics:

  • Working Capital Management Analysis

    • A company can be endowed with assets and profitability but short on liquidity if its assets cannot be converted into cash .
    • It is a derivation of working capital commonly used in valuation techniques such as discounted cash flows (DCFs).
    • The goal of working capital management is to ensure that the firm is able to continue its operations and that it has sufficient cash flow to satisfy both maturing short-term debt and upcoming operational expenses.
    • Working capital management entails short-term decisions, usually relating to the next one-year period and are based in part on cash flows and/or profitability.
    • Cash flows can be evaluated using the cash conversion cycle -- the net number of days from the outlay of cash for raw material to receiving payment from the customer.

  • Basic Components of Asset Valuation

    • Absolute value models that determine the present value of an asset's expected future cash flows.
    • These kinds of models take two general forms: multi-period models such as discounted cash flow models or single-period models such as the Gordon model.
    • When a plant asset is purchased for cash, its acquisition cost is simply the agreed on cash price.
    • However, when a business acquires plant assets in exchange for other non-cash assets (shares of stock, a customer's note, or a tract of land) or as gifts, it is more difficult to establish a cash price.
    • The general rule on non-cash exchanges is to value the non-cash asset received at its fair market value or the fair market value of what was given up, whichever is more clearly evident.

  • Preparation of the Statement of Cash Flows: Direct Method

    • There is an indirect and a direct method for calculating cash flows from operating activities.
    • The following is an example of using the direct method for calculating cash flows.
    • For example, if the interest expense is ten dollars, and the unamortized discount decreases by three dollars, then the cash paid for interest is seven dollars.
    • Cash flows refer to inflows and outflows of cash from activities reported on an income statement.
    • Explain the direct method for preparing the statement of cash flows

  • Introduction to the Statement of Cash Flows

    • The statement of cash flows show the company's ability to change cash flows in future circumstances.
    • The statement of cash flows also reconciles the cash balance from one balance sheet to the next.
    • The cash flow statement includes only inflows and outflows of cash and cash equivalents.
    • The Statement of Cash Flows is composed of three sections:
    • The statement of cash flows shows the liquidity of a company.

  • Importance of Cash Flow Accounting

    • The statement of cash flows provides insight that the balance sheet and income statement do not, particularly in regard to a company's cash position.
    • Cash flow is the movement of money into or out of a business, project, or financial product from operating, investing, and financing activities.
    • Without positive cash flow, a company cannot meet its financial obligations .
    • In addition, management uses cash flow for the following:
    • In addition, cash flow can be used to evaluate the "quality" of income generated by accrual accounting.

  • Bonds Issued at a Discount

    • The journal entry for that transaction would be as follows: Cash $90,000 Discount $10,000 Bond Payable $100,000The interest expense each period is $6,000, and the amortization rate on the bond payable equals $1,000 ($100,000/10 years).
    • The journal entry will be: Interest Expense $7,000 Discount $1,000 Cash $6,000When the bond matures, the business must record the repayment of the principal to the bondholder, as well as all final interest payments.
    • In this example, the journal entries will be: Interest Expense $7,000 Discount $1,000 Cash $6,000 Bond Payable $100,000 Cash $100,000
    • Because the issuer receives less cash for the bond than the face value, this difference must be recorded in the company records as a discount expense.
    • At this time, the discount on bond payable and bond payable accounts must be zeroed out, and all cash payments must be recorded.

  • Key Considerations for the Statement of Cash Flows

    • The statement of cash flows highlights the activities that directly and indirectly affect a company's overall cash balance.
    • A cash flow statement provides information beyond that available from other financial statements, such as the Income Statement and the Balance Sheet, through providing a reconciliation between the beginning and ending balances of cash and cash equivalents of a firm over a fiscal or accounting period.The main purpose of the statement, according to the Financial Accounting Standard Board (FASB) is to provide information about the changes of an entity's cash or cash equivalents in the accounting period .
    • It does not predict future cash flows.
    • The statement of cash flows lists all cash inflows and outflows during a reporting period from operating, investing and financing activities.
    • Summarize what items are represented on the statement of cash flows

  • Preparation of the Statement of Cash Flows: Indirect Method

    • Therefore, cash operating expenses were only $80,000.The net cash flow from operating activities, before taxes, would be:Cash flow from revenue: $89,000Cash flow from expenses: $(80,000)Net cash flow: $9,000The indirect method would find these cash flows as follows.Revenue: $125,000Expenses: $(85,000)Net Income: $40,000The adjustments for cash flow would then be made to this amount of net income. $36,000 would be subtracted due to the increase in accounts receivable, and $5,000 would be added due to the increase in accounts payable.
    • The following rules can be followed to calculate cash flows from operating activities:
    • So, depreciation expense is shown (or captioned) on the statement of cash flows.
    • The net cash flow from operating activities, before taxes, would be:
    • Explain how to use the indirect method to calculate cash flow

  • Impairment Measurement

    • Perform a recoverability test is to determine if an impairment loss has occurred by evaluating whether the future value of the asset's undiscounted cash flows is less than the book value of the asset.
    • If the cash flows are less than book value, the loss is measured.
    • The use of undiscounted cash flows in determining impairment loss assumes that the cash flows are certain and risk-free, and the timing of the cash flows is ignored.
    • The expected undiscounted cash flows generated by the machine after the damage are:
    • Since the asset's future undiscounted cash flows are USD 6,000, less than the USD 10,000 book value, an impairment loss has occurred.

  • Bonds Issued at Par Value

    • The affected accounts will be interest expense and cash, and the journal entry will be as follows: Interest Expense $70 Cash $70At bond expiration, the creditor must make a journal entry for the last interest payment and the retirement of the bond through principal payment.
    • The journal entry would be: Bond Payable $1,000 Cash $1,000
    • This generally means that the bond's market and contract rates are equal to each other, meaning that there is no bond premium or discount.
    • First, the business issues the bond in exchange for cash.
    • To balance this entry, the company must also debit cash equal to the face value of all the bonds issued.