What can you do to keep your business investments under your control? If you are going to further develop the company, for example by planning to expand the production portfolio, production capacities and equipment, warehouse space, or fleet, your priority will probably be cash flow. Investments are characterized not only by high capital intensity, but also by their long-term impact and relative irreversibility of the decision to purchase the investment. Cash flow management is a natural part of financial management of successful companies. This also applies to the company’s investment activities. 

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To succeed, you need to concentrate your inputs in a single (information) system that can work with them to avoid surprises, as you can consider all significant expenses in advance, just as most likely scheduled income the investment will bring. A good information system will do a lot of work for you. 

But which inputs should you provide to make the predicted cash flow as accurate as possible for investment planning? 

Inputs for investment cash flow prediction 

Each investment is specific to some extent. Investment decisions are based on the evaluation of the development of monetary income and expenses. A significant input is the current state of resources usable for the acquisition of investments. Other necessary inputs are increases in revenues if the investment triggers them, or, for example, a repayment schedule in the case of a loan. If it is necessary to hire additional labour, then add monthly payrolls, regular tax payments, and social security and health insurance to your cash flow forecast. 

Also include other assumptions in your outlook, such as the costs caused by the investment or the potential savings that the investment will bring, whether due to lower energy use or, for example, release of labour. Don’t forget the outlook for business cases that will be affected by the investment. Other projections for the course of cash flow include the definition of investments caused by overhead expenses, for example repairs and maintenance of buildings or servicing of new equipment. 

Two key decisions 

To truly control your investments, make two key decisions before making a specific investment: 

The investment decision will answer the question of whether the investment should be made or not. In other words, it is first necessary to decide whether the assessed investment sufficiently meets the set goals of the company. The procedure for economic evaluation of an investment is as follows. First, determine the capital expenditures spent on the investment. These include not only the acquisition price of the investment itself, but also one-off costs associated with the investment activity. These can be, for example, structural changes of the premises where the acquired technology will be placed, demolition work freeing up space for new construction or, for example, the costs of project documentation. 

The next step is to estimate future cash flows resulting from the proposed investment. If the relevant cash flows are incorrectly predicted in the individual years of the investment’s life, incorrect conclusions may be drawn on the basis of the economic analysis of the investment project as to whether it is really appropriate to implement or reject the considered variant. 

Finally, it is necessary to choose a suitable method for evaluating the economic efficiency of the investment project. For example, you can choose from cost methods. They take account only of changes in capital expenditures and operating costs. They are suitable for projects with the same outputs (bringing the same volume of production) and different technical and technological conditions. This is often a replacement investment where you replace the original technologies with new ones. They are also used for intended investments, where it is very difficult to quantify their benefits. 

If, on the other hand, the investment causes an increase in revenues (it is a developmental investment), then methods based on comparing the spent capital with the income that the investment will bring are appropriate. The decisive criteria here are rate of return (= the relationship between profit and costs of the acquisition and operation of the investment), risk level (= degree of risk that the expected returns will not be achieved) and payback period (= time to convert the investment back into monetary form). 

Project funding 

Have you decided to go for the investment? Then a financial decision awaits you. It is necessary to decide how to fund the investment project in order for it to be financially stable and optimal in terms of the costs of funding sources. The chosen funding structure determines how and when the project proceeds will be distributed among investors (owners and other potential investors – creditors). 

In terms of funding sources, the selected investment option needs to be planned in the individual stages of the project. You can use your own resources, for example by increasing the registered capital, increasing other capital funds, using funds created from profit or retained earnings of previous years. More often, however, resources outside the company’s operating activities are used, especially increase in liabilities, drawing of bank credits, obtaining a loan in a group, issuance of bonds, or receipt of a subsidy. 

The impact of investments on the company’s funding 

The investment budget depends on the company’s financial capabilities, the need for investments and their potential for return. The proposed investment plans need to be subject to a basic evaluation in order to select those that have the expected benefits higher than the costs. Before fully approving or rejecting an investment plan, analyse the economic impact of the investment on the company’s overall economy. 

The growth rate of total investments should not be higher than the growth rate of revenues. This economic rule is based on the logical reasoning that new investments must be paid by the existing ones. Investments may not always increase revenues. If this situation occurs, the rate of investment growth needs to be slowed down and the situation stabilized. If the company adheres to this rule, it is easier to avoid investments that do not translate into increased sales. 

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Article author: Pavlina Vancurova, Ph.D. from  Padia

Ing. Pavlína Vančurová, Ph.D.

In cooperation with Pavlina Vancurova, Ph.D., specialist in business economics from consulting firm PADIA, we have prepared the Caflou cash flow academy for you, the aim of which is to help you expand your knowledge in the field of cash flow management in small and medium-sized companies.

In her practice, Pavlina provides economic advice in the area of financial management and setting up controlling in companies of various fields and sizes. In 2011, she co-founded the consulting company PADIA, where she works as a trainer and interim financial director for a number of clients. She also draws on her experience as the executive director of an international consulting firm. She worked as a university teacher and is the author of a number of professional publications.