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enHow to Calculate the Payback Period in Excel
https://economicpoint.com/payback-period-excel
<div class="field field-name-body field-type-text-with-summary field-label-hidden view-mode-rss"><div class="field-items"><div class="field-item even" property="content:encoded"><p>The payback period is the time it takes for a project to recover the investment cost. For example, if you invest $100 and the returns are $50 per year, you will recover your initial investment in two years. </p>
<p><img src="/sites/default/files/payback_in_excel_2.png" alt="How to Calculate the Payback Period in Excel, illustration" /></p>
<p>The payback period is a simple and quick way to asses the convenience of an investment project and to compare different projects. For example, if project A has a payback period of three years, while project B has a payback period of four years, you will choose project A. </p>
<p>Can you notice an issue with the payback period? Think for a moment. <span class="caps">OK</span>, the payback period has two main <strong>issues</strong>:</p>
<ol><li>It doesn’t take the time value of money into account.</li>
<li>It doesn’t take into account all the cash flows that happen after the accumulated cash flow is zero. </li>
</ol><p>The time value of money is an economic concept that refers to the fact that money available in a near future is worth more than the identical sum in a far future. </p>
<p>The payback period can be seen as the time it takes a project, to reach an accumulated cash flow of zero. But two different projects can have the same payback period, while the first one has larger positive cash flows after the payback period. Clearly, the first one is preferable. </p>
<h2 id="alternatives">Alternatives to the Payback Period</h2>
<p>Because of the issues with the payback period, the Internal Return Rate (<span class="caps">IRR</span>) and the Net Present Value (<span class="caps">NPV</span>) are better alternatives to the <span class="caps">PP</span>. These measurements do take the time value of money and all the cash flows into account.</p>
<h2 id="examples">Examples of the Payback Period</h2>
<h3>Same cash flow every year</h3>
<p>When the cash flow remains constant every year after the initial investment, the payback period can be calculated using the following formula:</p>
<p><span class="caps">PP</span> = Initial Investment / Cash Flow</p>
<p>For example, if you invested $10,000 in a business that gives you $2,000 per year, the payback period is $10,000 / $2,000 = 5</p>
<p><img src="/sites/default/files/payback-1.png" alt="Payback when all cash flows are the same" /></p>
<p>If you invested $8,000 and the cash flow remains $2,000 per year, the payback period reduces to 4 years:</p>
<p><img src="/sites/default/files/payback-2.png" alt="Payback in Excel when all cash flows are the same, 8000 investment and 2000 cash flow" /></p>
<p>Another way to view the payback period is to check when the accumulated cash flow, including all the investments, equals zero. But sometimes this is not so easy, because there is a period of negative accumulated cash flow followed by a period with positive accumulated cash flow. There is no period with zero accumulated cash flow. </p>
<p>In this case, what period do we take into account? The first one or the second one? </p>
<p>When there is no period of zero accumulated cash flow, the payback period will be a positive rational number, not an integer. To calcul the payback, you must estimate the fraction of the year that passed since the cash flow was negative for the last time until it reached the zero value. For this estimation, we assume a linear behavior of the evolution of the cash flow. </p>
<p>If the absolute value of the last negative accumulated cash flow is the same as the first accumulated positive one, the fraction is 0.5, like in the following example:</p>
<p><img src="/sites/default/files/payback-3.png" alt="Payback in Excel when cash flows are different" /></p>
<p>In the following plot, we can see the evolution of the accumulated cash flow:</p>
<p><img src="/sites/default/files/payback-4.png" alt="Evolution of the Cash Flow in the Payback" /></p>
<p>When the absolute value of the last accumulated cash flow is not the same as the first positive cash flow, the fraction will not be 0.5:</p>
<p><img src="/sites/default/files/payback-5.png" alt="Uneven Cash Flow in the Payback with Excel" /></p>
<p><img src="/sites/default/files/payback-6.png" alt="Evolution of the Cash Flow in the Payback" /></p>
<h2 id="excel">How to Calculate the Payback Period in Excel</h2>
<p>While is it possible to have a single formula to calculate the payback, it is better to split the formula into several partial formulas. This way, it is easier to audit the spreadsheet and fix issues. </p>
<p>Follow these steps to calculate the payback in Excel:</p>
<ul><li>Enter all the investments required. Usually, only the initial investment.</li>
<li>Enter all the cash flows.</li>
<li>Calculate the Accumulated Cash Flow for each period</li>
<li>For each period, calculate the fraction to reach the break even point. Use the formula “<span class="caps">ABS</span>”</li>
<li>Count the number of years with negative accumulated cash flows. Use the formula “<span class="caps">IF</span>” </li>
<li>Find the fraction needed, using the number of years with negative cash flow as index. Use the formula “<span class="caps">INDEX</span>”</li>
<li>To get the exact payback period, sum the number of years with negative accumulated cash flow and the corresponding fraction</li>
</ul><p>Shameless plug: We created an Excel file to calculate the payback. It updates automatically and allows to enter multiple investments, not only an initial investment. It displays the payback using fraction years and also years months and days. Actually, we used this file to create our examples, you can get it for only $3 using the following link:</p>
<p><a style="font-weight:bold" href="https://www.buymeacoffee.com/l/PaybackExcel">Payback Period in Excel</a></p>
</div></div></div><section class="field field-name-field-tags field-type-taxonomy-term-reference field-label-above view-mode-rss"><h2 class="field-label">Tags: </h2><ul class="field-items"><li class="field-item even"><a href="/terms/excel" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Excel</a></li><li class="field-item odd"><a href="/terms/investment" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Investment</a></li><li class="field-item even"><a href="/terms/financial" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Financial</a></li></ul></section>Fri, 03 May 2019 20:30:08 +0000EconomicPoint134 at https://economicpoint.comNPV Formula in Excel
https://economicpoint.com/npv-formula-excel
<div class="field field-name-body field-type-text-with-summary field-label-hidden view-mode-rss"><div class="field-items"><div class="field-item even" property="content:encoded"><p>The <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> formula in Excel is counterintuitive at first. When I first used it, I made a simple mistake by selecting all the cash flow, including the initial investment. I learned that Excel requires you to select only the future flows and then discount the initial investment from the result, to get the accurate <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> value. </p>
<p>In my experience, a lot of colleagues do the same mistake and never realize that they are using the <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> formula in the wrong way because the numerical difference is minor. Even some websites are showing the wrong way to calculate the <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> in Excel. </p>
<p>This is because Microsoft Excel assumes that the first period to be used in the formula, is not the “zero” year, but one year in advance. </p>
<p>Let’s dig deeper into the <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> formula and you will understand what I’m talking about:</p>
<h2>The Cash Flow in the <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> Formula</h2>
<p>The <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> formula in Excel is called, guess what, “<span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span>”. As we all know, <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> stands for Net Present Value. The <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> is the present value of a discounted cash flow. That is: the current value of this cash flow, including not only years with positive flows but also years with negative cash flow. Usually, the cash flow includes also the initial investment. The initial investment is the investment done in period “zero” before any cash inflow.</p>
<p>Here comes the tricky part, in Excel, the cash flow doesn’t include the initial investment. For example, if our cash flow is as follows:</p>
<p><img src="https://economicpoint.com/sites/default/files/npv-formula-excel-1.png" alt="excel" /></p>
<p>We must not include “-100,000” (cell <span class="caps">C5</span>) in the actual Excel <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> formula, but only all the following values, and then subtract 100,000 from the result. </p>
<h2>The Discount Rate in the <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> Formula</h2>
<p>To use the <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> formula, we need a discount rate. A discount rate is usually the rate of return of the best alternative investment with a similar risk profile. For example, if we have an alternative investment with a rate of return of 5% yearly and the same risk as the investment we are currently analyzing, we should use 5% as the discount rate in the <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> formula. </p>
<p>So, there are two key data that we must know to use the <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> formula in Excel:<br />
1- The Cash Flow (don’t forget to not include the initial investment in the actual <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> formula)<br />
2- The Discount Date</p>
<p>Many Excel users do the mistake of including the initial investment in the actual <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> formula, and the difference with the right way to do it is minor. Because the difference is small, a lot of people get the wrong value and do not notice it. </p>
<h2>Instructions to use the <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> formula in Excel</h2>
<p>Knowing all this, let’s do it:</p>
<h3>Step 1: Insert your Cash Flow</h3>
<p>Insert all the cash flows. They can be calculated annually, monthly or using another time period, but you must take into account that the discount rate must correspond to the time period used in the cash flow. </p>
<p>For example, if you have years in your cash flow, you must use a discount rate expressed in years. To get a monthly rate from a yearly rate, use the following formula:</p>
<p>=(1+<span class="caps">A1</span>)^(1/12)-1</p>
<p>Where <span class="caps">A1</span> is the cell that contains the yearly rate. For example, if you have a yearly rate of 20%, the monthly rate is near 1.53%. Note: in this example, the values are expressed in actual numbers: 0.20 is the yearly rate and 0.015309 the monthly rate. </p>
<p>Regarding the initial investment or the cash flow in period zero, I usually put this value in the same cash flow, but you can also use a cell distant from the future cash flow. </p>
<h2>Step 2: Insert the Discount Rate</h2>
<p>Afther entering the cash flow and the discount rate, your sheet will look like this one: </p>
<p><img src="/sites/default/files/npv-formula-excel-2.png" alt="npv formula" /></p>
<h3>Step 3: Enter the <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> Excel Formula</h3>
<p>Insert “=<span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span>(<span class="caps">E3</span>,<span class="caps">B5</span>:<span class="caps">B14</span>)+<span class="caps">B4</span>”<br />
where:<br /><span class="caps">E3</span> is the cell containing the discount rate<br /><span class="caps">B5</span>:<span class="caps">B14</span> is the range containing the future cash flows<br /><span class="caps">B4</span>: is the cell containing the initial investment </p>
<p><img src="/sites/default/files/npv-excel-cash-formula.png" alt="npv cash flow" style="width:698px;height:455px" /></p>
<h2>Working Example</h2>
<p><video id="movie" width="598" height="572" controls="" controlslist="nodownload"><source src="/sites/default/files/npv-excel.mp4"></source><source src="/sites/default/files/npv-excel.webm"></source><br /><track label="English" kind="captions" srclang="en" src="https://economicpoint.com/sites/default/files/npv-excel-caption.vtt" default=""></track></video></p>
</div></div></div><section class="field field-name-field-tags field-type-taxonomy-term-reference field-label-above view-mode-rss"><h2 class="field-label">Tags: </h2><ul class="field-items"><li class="field-item even"><a href="/terms/excel" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Excel</a></li><li class="field-item odd"><a href="/terms/financial" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Financial</a></li></ul></section>Fri, 08 Mar 2019 12:25:11 +0000EconomicPoint126 at https://economicpoint.comFinancial Resources Examples
https://economicpoint.com/financial-resources-examples
<div class="field field-name-body field-type-text-with-summary field-label-hidden view-mode-rss"><div class="field-items"><div class="field-item even" property="content:encoded"><ul><li><strong>Cash</strong>: money or its equivalent. </li>
<li><strong>Bank Deposits</strong>: money placed into banks, including checking accounts and money market accounts. </li>
<li><strong>Holdings of Stocks</strong>: publicly traded stocks can be easily converted to cash, and are considerer financial resources of an organization. This stocks are traded on stocks exchanges, like the <span class="caps">NASDAQ</span> or the <span class="caps">NYSE</span>. It takes only a few minutes to sell stocks on the market. </li>
<li><strong>Holdings of Publicly Traded Bonds</strong>: There are various types of bonds that can be included in the financial resources of an organization: <span class="caps">U.S.</span> government securities, mortgage bonds, foreign bonds, corporate bonds, etc. </li>
<li><strong>Foreign <a href="https://economicpoint.com/tools/currency-converter" class="alinks-link" title="Currency Converter">Currency</a> Holdings</strong>: These are currencies issued in another country. Foreign currencies can be held in a local or in a foreign bank. Foreign currency can be quicly converted to local currency, thus they are considered part of the financial resources of an organization. Also, many international companies need to hold amounts of foreign currency to carry out its operations, like selling abroad or paying foreign suppliers. </li>
<li><strong>Checks</strong>: checks are instruments that contain an order that directs a bank to pay an amount of money to the check holder. Check can be easily converted to money, and sometimes, checks can be used to pay to suppliers: checks are financial assets. </li>
</ul><p>Financial Resources are assets of the organization, and are used to carry out the business activities, like paying salaries and buying supplies. </p>
<p><strong>Sources of financial resources</strong>:<br />
- The main activities of the business, like the sale of goods and services.<br />
- Capital funding: issues of shares and capital contributions<br />
- External sources: bank loans and issues of corporate bonds </p>
</div></div></div><section class="field field-name-field-tags field-type-taxonomy-term-reference field-label-above view-mode-rss"><h2 class="field-label">Tags: </h2><ul class="field-items"><li class="field-item even"><a href="/resources" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Resources</a></li><li class="field-item odd"><a href="/terms/management" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Management</a></li><li class="field-item even"><a href="/terms/financial" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Financial</a></li></ul></section>Thu, 13 Sep 2018 17:44:11 +0000EconomicPoint120 at https://economicpoint.comIRR calculation in Excel
https://economicpoint.com/irr-internal-return-rate-excel
<div class="field field-name-body field-type-text-with-summary field-label-hidden view-mode-rss"><div class="field-items"><div class="field-item even" property="content:encoded"><p>This article teaches you how to calculate the <span class="caps">IRR</span> (Internal Return Rate) using Excel. The Excel function to calculate the <span class="caps">IRR</span> is “<span class="caps">IRR</span>” and it’s really simple, since it only takes the range that contains the flow of funds, including the initial investment.</p>
<p>The <span class="caps">IRR</span>, or Internal Rate of Return, is the interest rate that makes the present value of a flow of funds equal to zero. The present value of a cash flow is the current worth of it. To know the current value, you must use a discount rate. The <span class="caps">IRR</span> calculation includes all positive and negative flows, it includes the initial investment. </p>
<p>To know if an investment project is desirable, we must compare the <span class="caps">IRR</span> with the rate of return of the best available investment alternative. If the <span class="caps">IRR</span> is greater than the rate of the best alternative, the project is desirable. </p>
<p><video id="movie" width="746" height="556" controls="" controlslist="nodownload"><source src="/sites/default/files/irr-excel.mp4"></source><source src="/sites/default/files/irr-excel.webm"></source><br /><track label="English" kind="captions" srclang="en" src="/sites/default/files/irr-excel-caption.vtt" default=""></track></video></p>
<p><strong><span class="caps">STEP</span> 1: Know your Cash Flow</strong></p>
<p>The first step to calculate the <span class="caps">IRR</span> using Excel is to input all the cash flows of the investment project. </p>
<p>Future cash flows are usually estimated using a model. </p>
<p><img src="/sites/default/files/irr-excel-flows.png" alt="IRR cash flow" style="width:387px;height:422px" /></p>
<p><strong><span class="caps">STEP</span> 3: Enter the <span class="caps">IRR</span> Excel Formula</strong></p>
<p>The <span class="caps">IRR</span> formula requires only one arguments, the range that containing the cash flows, including the initial investment. </p>
<h2>Excel Formula:</h2>
<p><code>=IRR(B4:B14)</code></p>
<p>Where:<br /><span class="caps">B4</span>:<span class="caps">B14</span>: range containing the future cash flows </p>
<p><img src="/sites/default/files/irr-excel-formula.png" alt="IRR Excel Formula" style="width:934px;height:543px" /></p>
<p>Press Enter and Excel will calculate the <span class="caps">IRR</span>.</p>
<p><img src="/sites/default/files/irr-excel-result.png" alt="IRR Excel" style="width:458px;height:92px" /></p>
</div></div></div><section class="field field-name-field-taxonomy-terms field-type-taxonomy-term-reference field-label-above view-mode-rss"><h2 class="field-label">Taxonomy Terms: </h2><ul class="field-items"><li class="field-item even"><a href="/terms/excel" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Excel</a></li><li class="field-item odd"><a href="/terms/financial" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Financial</a></li></ul></section>Thu, 18 Jan 2018 13:36:40 +0000EconomicPoint113 at https://economicpoint.comHow to Calculate the NPV in Excel?
https://economicpoint.com/npv-net-present-value-excel
<div class="field field-name-body field-type-text-with-summary field-label-hidden view-mode-rss"><div class="field-items"><div class="field-item even" property="content:encoded"><p>This article teaches you how to calculate the <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> (Net Present Value) using Excel. The Excel function to calculate the <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> is “<span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span>”.</p>
<p>The <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span>, or Net Present Value, is the present value, or actual value, of a future flow of funds. The present value of a future cash flow is the current worth of it. To know the current value, you must use a discount rate. The <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> includes not only the positive cash flows, or inflows, but also all expenditures, including the initial investment. </p>
<p>If the <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> is positive, it means that the actual value of all incomes is higher than the actual value of all expenditures, and the investment is desirable, because it adds more value than the best alternative. </p>
<p>The cash flows are discounted using a discount rate that corresponds to the best alternative investment. </p>
<p><video id="movie" width="598" height="572" controls="" controlslist="nodownload"><source src="/sites/default/files/npv-excel.mp4"></source><source src="/sites/default/files/npv-excel.webm"></source><br /><track label="English" kind="captions" srclang="en" src="https://economicpoint.com/sites/default/files/npv-excel-caption.vtt" default=""></track></video></p>
<p><strong><span class="caps">STEP</span> 1: Know your Cash Flow</strong></p>
<p>The first step to calculate the <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> using Excel is to input all the cash flows of the investment project. Usually, the flows are calculated annually, but you can use months also. Take into account that the discount rate period must correspond to the cash flows period. For example, if you use annual cash flows, the discount rate must be annual.</p>
<p>The cash flows are usually estimated using a model. </p>
<p><img src="/sites/default/files/npv-excel-cash-flow.png" alt="npv cash flow" style="width:439px;height:562px" /></p>
<p><strong><span class="caps">STEP</span> 2: Know your Discount Rate</strong></p>
<p>Select a cell and enter your discount rate. For example, if your discount rate is 10%, you should enter 0.1 </p>
<p>Remember that the discount rate is the rate of return of your best alternative investment with similar risk to the current project. </p>
<p><img src="/sites/default/files/npv-excel-discunt-rate.png" alt="npv cash flow" style="width:354px;height:42px" /></p>
<p><strong><span class="caps">STEP</span> 3: Enter the <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> Excel Formula</strong></p>
<p>The <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> formula requires 2 arguments: </p>
<p>1. The discount rate: cell <span class="caps">E1</span> in our example<br />
2. The cash flow range: range <span class="caps">B5</span>:<span class="caps">B14</span> in our example. </p>
<p>Please take into account that the Excel <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> formula starts with the first period, and the initial investment occurs in period “0”. So, we must subtract the initial investment from the previous calculation. <code>Note: some websites are wrong, they include the initial investment into the NPV formula. This leads to a minor difference, because Excel assumes the first period is one year in advance. </code></p>
<h2>Excel Formula:</h2>
<p><code>=NPV(E3,B5:B14)+B4</code></p>
<p>Where:<br /><span class="caps">E3</span>: cell containing the discount rate.<br /><span class="caps">B5</span>:<span class="caps">B14</span>: range containing the future cash flows<br /><span class="caps">B4</span>: cell containing the initial investment (in this example, the initial investment is expressed in negative values, that is why we add it)</p>
<p>Press Enter and Excel will calculate the <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span>.</p>
<p><img src="/sites/default/files/npv-excel-cash-formula.png" alt="npv cash flow" style="width:698px;height:455px" /></p>
</div></div></div><section class="field field-name-field-taxonomy-terms field-type-taxonomy-term-reference field-label-above view-mode-rss"><h2 class="field-label">Taxonomy Terms: </h2><ul class="field-items"><li class="field-item even"><a href="/terms/excel" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Excel</a></li><li class="field-item odd"><a href="/terms/financial" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Financial</a></li></ul></section>Thu, 18 Jan 2018 11:49:23 +0000EconomicPoint112 at https://economicpoint.comFinancial Planning
https://economicpoint.com/financial-planning
<div class="field field-name-body field-type-text-with-summary field-label-hidden view-mode-rss"><div class="field-items"><div class="field-item even" property="content:encoded"><p>Financial planning is a process that evaluates the situation of a business in relation to it’s financial resources and needs and determines how to manage the liquid assets, taking the future inflows and outflows of funds into accounts.</p>
<p>The main purposes of financial planning are:<br />
- Avoid situations of shortage of financial resources that can be detrimental to the accomplishment of the goals of the organization. A business can be profitable in the long term, but a bad financial management can lead to short term bankruptcy.<br />
- Avoid a high opportunity cost of maintaining a high stock of financial assets.<br />
- Allow the organization to take advantage of business opportunities.</p>
<p>Financial planning must be aligned with the goals and the vision of the organization. It is not an objective of financial planning to establish long term goals, but financial planning can influence short term planning.</p>
<p>The making of cash flow reports and budgets are important activities of financial planning. Budgets are a tool of planification that show the financial behavior of different parts or units of the organization. Cash flow reports contain inflows and outflows of cash.</p>
<p>Financial planning should take into account the variables of the environment in which the organization operates and the possible impact that changes in those variables can have in the financial resources of the business. A good financial management should react quickly to changes in the environment and to changes of internal variables.</p>
<p>Financial planning makes estimations of future values of several variables, like:<br />
- Level Sales<br />
- Operative costs<br />
- Assets of the organization and its liquidity<br />
- Interest rate<br />
- Future investments</p>
</div></div></div><section class="field field-name-field-tags field-type-taxonomy-term-reference field-label-above view-mode-rss"><h2 class="field-label">Tags: </h2><ul class="field-items"><li class="field-item even"><a href="/terms/financial" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Financial</a></li><li class="field-item odd"><a href="/terms/management" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Management</a></li></ul></section>Mon, 08 Jun 2015 13:47:59 +0000EconomicPoint88 at https://economicpoint.comFinancial Resources
https://economicpoint.com/financial-resources
<div class="field field-name-body field-type-text-with-summary field-label-hidden view-mode-rss"><div class="field-items"><div class="field-item even" property="content:encoded"><p><strong><em>Financial Resources</em> is the set of liquid assets of an organization, including cash, bank deposits and liquid financial investments. </strong></p>
<h2>Financial Resources</h2>
<ul><li>Cash</li>
<li>Short term bank deposits</li>
<li>Liquid financial investments, like stocks and bonds</li>
</ul><p>Financial resources are used to carry out the main operations of the business, like buying goods and services and to carry out long term investments.</p>
<h2>Financial Resources Management</h2>
<p><strong>Good financial resources management</strong> is key to achieve the goals of the organization. Situations in which the shortage of funds can compromise the short term operations must be avoided. For example, if the organization doesn’t have enough funds to pay salaries or buy raw materials. On the other side, an excess of financial resources can lead to a high opportunity cost.</p>
<p><strong>Budget control and analysis</strong> play an important role in Financial Resources Management. Efficient management should react quickly to changes in the environment and pursue a healthy stock of financial resources, according to the needs.</p>
<h2>Sources of Financial Resources</h2>
<ul><li><strong>Business Operations</strong>: main business activities, like the sale of goods and services.</li>
<li><strong>Capital Funding</strong>: issues of shares and capital contributions.</li>
<li><strong>External Sources</strong>: bank loans and issues of corporate bonds.</li>
</ul></div></div></div><section class="field field-name-field-tags field-type-taxonomy-term-reference field-label-above view-mode-rss"><h2 class="field-label">Tags: </h2><ul class="field-items"><li class="field-item even"><a href="/resources" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Resources</a></li><li class="field-item odd"><a href="/terms/management" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Management</a></li><li class="field-item even"><a href="/terms/financial" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Financial</a></li></ul></section>Thu, 04 Jun 2015 12:23:04 +0000EconomicPoint87 at https://economicpoint.comCapital Budgeting
https://economicpoint.com/capital-budgeting
<div class="field field-name-body field-type-text-with-summary field-label-hidden view-mode-rss"><div class="field-items"><div class="field-item even" property="content:encoded"><p><strong>Capital budgeting is a process that assess the convenience of carrying out an investment or not</strong>. If there are many profitable investments available, the capital budgeting tries to find out which one is more advisable. </p>
<p>There are different measurements to find out which investment is more profitable. When we are evaluating a private investment, the criteria of private profitability should be take into account. When we are evaluating a public investment, social benefits and costs should be taken into account. In both scenarios, we have to take other considerations into account, like the investment risk.</p>
<p><strong>An investment will be beneficial for the investor if it’s able to generate added value for him</strong>. This happens when profits outweigh costs. Within costs, we have to take into consideration the opportunity costs of the investment, that will be given by the best alternative investment with similar risk. </p>
<p>We will describe some measures for capital budgeting. But first, we need to analyze some <strong>important elements of investment projects</strong> that are needed for capital budgeting:</p>
<h2>Initial investment</h2>
<p>It is the expenditure that is made in the first period. For example, if we are assessing the purchase of a car to be used as a taxi, the initial investment will be the price of the car plus all expenses to make the car a taxi (painting, legal paperwork, etc.).</p>
<h2>Cash Flow</h2>
<p>It’s a report that contains the flow of money into or out of a business. In the case of capital budgeting, we will use an expected cash flow, that contains estimations of future flows of money. For example, if the initial investment for the taxi was $10.000 and it will produce a net income of $1.000 during one year, at the end of which the taxi will be sold for $5.000, the cash flow will be the following:</p>
<table><tbody><tr><td></td>
<td>- $10,000.00</td>
</tr><tr><td>1</td>
<td>$1,000.00</td>
</tr><tr><td>2</td>
<td>$1,000.00</td>
</tr><tr><td>3</td>
<td>$1,000.00</td>
</tr><tr><td>4</td>
<td>$1,000.00</td>
</tr><tr><td>5</td>
<td>$1,000.00</td>
</tr><tr><td>6</td>
<td>$1,000.00</td>
</tr><tr><td>7</td>
<td>$1,000.00</td>
</tr><tr><td>8</td>
<td>$1,000.00</td>
</tr><tr><td>9</td>
<td>$1,000.00</td>
</tr><tr><td>10</td>
<td>$1,000.00</td>
</tr><tr><td>11</td>
<td>$1,000.00</td>
</tr><tr><td>12</td>
<td>$6,000.00</td>
</tr></tbody></table><p>Because it’s a future cash flow, we are talking about estimations. An important part of capital budgeting has to do with making accurate estimations. Besides, there are ways to take into account the probability that the expected value will be different as the observed value one encounters in reality.</p>
<h2>Discount Rate</h2>
<p>As mentioned earlier, capital budgeting takes the opportunity costs into consideration. The discount rate is usually the yield rate of the best alternative investment with similar risk. </p>
<h2>Measurements to find out the best investment alternatives</h2>
<h3>Net Present Value</h3>
<p>The Net Present Value (<span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span>) is the sum of the discounted cash flows. </p>
<p>Example: there is an investment project with only 2 periods, initial investment and sale of the investment. The initial investment is $1000 and after 12 month, there will be a cash inflow of $1210. The best possible alternative with similar risk is 1 year bond with an annual yield of 10%. The net present value of this investment is -$1000 + $1210/1.1 = $100. </p>
<p>This means:<br />
- The present value of the investment yield is $100 higher than the best similar risk alternative.<br />
- If we make the investment, our wealth will increase in $100<br />
- It is advisable to actually carry out the investment</p>
<p>A second example:</p>
<table><tbody><tr><td></td>
<td>- $5,000.00</td>
</tr><tr><td>1</td>
<td>$1,000.00</td>
</tr><tr><td>2</td>
<td>$1,000.00</td>
</tr><tr><td>3</td>
<td>$1,000.00</td>
</tr><tr><td>4</td>
<td>$1,000.00</td>
</tr><tr><td>5</td>
<td>$1,000.00</td>
</tr><tr><td>6</td>
<td>$1,000.00</td>
</tr><tr><td>7</td>
<td>$1,000.00</td>
</tr><tr><td>8</td>
<td>$1,000.00</td>
</tr><tr><td>9</td>
<td>$1,000.00</td>
</tr><tr><td>10</td>
<td>$1,000.00</td>
</tr><tr><td>11</td>
<td>$1,000.00</td>
</tr><tr><td>12</td>
<td>$6,000.00</td>
</tr></tbody></table><p>And the discount rate is 10%.</p>
<p>In this case, to calculate the <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> we can do:<br /><span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> = -5000 + 1000/1.1 + 1000/1.12 + 1000/1.13 + … + 1000/1.111 + 1000/1.112 </p>
<p>The <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> is $3407, so it is advisable to carry out the investment.</p>
<p>Usually, the computation of the <span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span> is done by using a software like Microsoft Excel or Libreoffice Calc. </p>
<h2>Internal Rate of Return</h2>
<p>The Internal Rate of Return (<span class="caps">IRR</span>) is the discount rate that makes the net present value of the cash flows equal to zero. There is no need to know the discount rate to calculate the <span class="caps">IRR</span>. Once we have the <span class="caps">IRR</span> calculated, it is compared with the discount rate. If the <span class="caps">IRR</span> is greater than the discount rate, it is advisable to carry out the investment, and vice versa. </p>
<p>Let’s go back to the example of an investment with only 2 cash flows: the initial investment is $1000 and after one year there will be an inflow of money of $1210. In this case, it’s very easy to calculate the <span class="caps">IRR</span>: The <span class="caps">IRR</span> is 21%, because -$1000 + $1210/1.21 = 0. To know if this investment is advisable, we compare 21% with the yield rate of the best alternative. If the yield rate of the best alternative is 10%, it is advisable to carry out the investment.</p>
<h2>Return over investment</h2>
<p>The Return Over Investment (<span class="caps">ROI</span>) is the benefit resulting from an investment. It is calculated by subtracting the investment amount and losses from the cash inflows. It is a very simple measure. The percentage <span class="caps">ROI</span> is: net (benefit / investment) x 100.</p>
<p>Let’s go back to the example of an investment with just 2 cash flows. The initial investment is $1000 and after one year, there is an inflow of $1210. The <span class="caps">ROI</span> is $1210 - $1000 = $210. The percentage <span class="caps">ROI</span> is 21%. In this simple example, and because the investment project has only 2 flows, the <span class="caps">ROI</span> is the same as the <span class="caps">IRR</span>. But usually this is not the case. </p>
<p>Another example:</p>
<table><tbody><tr><td></td>
<td>- $5,000.00</td>
</tr><tr><td>1</td>
<td>$1,000.00</td>
</tr><tr><td>2</td>
<td>$1,000.00</td>
</tr><tr><td>3</td>
<td>$1,000.00</td>
</tr><tr><td>4</td>
<td>$1,000.00</td>
</tr><tr><td>5</td>
<td>$1,000.00</td>
</tr><tr><td>6</td>
<td>$1,000.00</td>
</tr></tbody></table><p>In this example, the <span class="caps">ROI</span> is $1000 and the percentage <span class="caps">ROI</span> is 20%.</p>
<h3>Discounted <span class="caps">ROI</span></h3>
<p>The <span class="caps">ROI</span> and the percentaje <span class="caps">ROI</span> are easy to understand and calculate, but they do not take the time into account. A project can generate 21% <span class="caps">ROI</span> in 1 year or 10 years, and the <span class="caps">ROI</span> will be the same. </p>
<p>To solve this issue, the discounted <span class="caps">ROI</span> can be calculated. The discounted <span class="caps">ROI</span> uses the discounted cash flows. The percentage discounted cash flow is a better measure than the percentage <span class="caps">ROI</span>.</p>
<h2><span class="caps">TL</span>;<span class="caps">DR</span></h2>
<p>Capital budgeting is a key element to estimate the profitability of an investment project before execution. The main elements needed by capital budgeting are the estimated cash flows and the discount rate. There are several measures for capital budgeting, the most important are the <span class="caps">IRR</span> and the <span class="caps">VPN</span>. The <span class="caps">ROI</span> must be used with caution.</p>
</div></div></div><section class="field field-name-field-tags field-type-taxonomy-term-reference field-label-above view-mode-rss"><h2 class="field-label">Tags: </h2><ul class="field-items"><li class="field-item even"><a href="/terms/investment" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Investment</a></li><li class="field-item odd"><a href="/terms/capital-budgeting" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Capital budgeting</a></li><li class="field-item even"><a href="/terms/financial" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Financial</a></li></ul></section>Tue, 19 May 2015 19:58:26 +0000EconomicPoint86 at https://economicpoint.comInvestment Project
https://economicpoint.com/investment-project
<div class="field field-name-body field-type-text-with-summary field-label-hidden view-mode-rss"><div class="field-items"><div class="field-item even" property="content:encoded"><h2>What is an Investment Project</h2>
<p>An investment project is a detailed proposal of an expenditure of liquid resources, with the objective of taking actions that will lead to future profits.</p>
<p>- An investment project is made before the investment itself.</p>
<p>- An investment implies an expenditure of resources, but it doesn’t necessarily means that those resources are our own resources: a lot of investments are carried out by borrowing money. </p>
<p>- There is a temporal difference between the expenditure and the procurement of the profits. The procurement of the profits is farther away in time. This is an important fact that must be taken into account during the capital budgeting. </p>
<p>- The investment will try to achieve a change in future reality, like satisfying certain needs of people.</p>
<p>- An investment project requires careful planning and includes detailed descriptions of expenditures and incomes (sources and expected amounts). Usually, investment projects also include a profitability evaluation with measures of capital budget, like the Net Present Value (<span class="caps"><a href="https://economicpoint.com/npv-calculator" class="alinks-link" title="NPV Calculator">NPV</a></span>) and the Internal Return Rate (<span class="caps">IRR</span>), along with a description of the investment risks. </p>
<h2>Examples of investment projects</h2>
<p>- Build a bridge that will allow people traveling from one sector of a city to another, to save traveling time.</p>
<p>- Build an apartment building that gives housing to 10 families. </p>
<p>- Buy a vessel to carry goods from China to <span class="caps">USA</span> and from <span class="caps">USA</span> to China. </p>
<p>- Build a hotel.</p>
<h2>Classification of Investment Projects</h2>
<p>- Public investment: when the capital comes from the public treasury (it can be carried out by the government of by a private company. Private investment: when the capital comes from private investors or private companies. </p>
<p>- According to the risk involved: high risk investment vs low risk investment. </p>
<p>- According to the kind of good or services it will provide:</p>
<p>Goods</p>
<ul><li>Industrial</li>
<li>Agricultural</li>
<li>Forestry</li>
<li>Fishing</li>
</ul><p>Services</p>
<ul><li>Transport</li>
<li>Commerce</li>
<li>Communications</li>
<li>Finance</li>
<li>Health</li>
<li>Etc. </li>
</ul><p><i>Image of Hands handing money to invest. By 401(K) 2012 [<span class="caps">CC</span> <span class="caps">BY</span>-<span class="caps">SA</span> 2.0 (<a href="http://creativecommons.org/licenses/by-sa/2.0">http://creativecommons.org/licenses/by-sa/2.0</a>)]<br />
Source: <a href="https://www.flickr.com/photos/68751915">https://www.flickr.com/photos/68751915</a>@<span class="caps">N05</span>/6848822477</i></p>
</div></div></div><section class="field field-name-field-tags field-type-taxonomy-term-reference field-label-above view-mode-rss"><h2 class="field-label">Tags: </h2><ul class="field-items"><li class="field-item even"><a href="/terms/investment" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Investment</a></li><li class="field-item odd"><a href="/terms/capital-budgeting" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Capital budgeting</a></li><li class="field-item even"><a href="/terms/financial" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Financial</a></li></ul></section>Fri, 08 May 2015 20:19:34 +0000EconomicPoint85 at https://economicpoint.comCash Flow Statement
https://economicpoint.com/cash-flow-statement
<div class="field field-name-body field-type-text-with-summary field-label-hidden view-mode-rss"><div class="field-items"><div class="field-item even" property="content:encoded"><p>The cash flow statement shows the inflows and outflows of cash generated and used by an organization in a given period of time. </p>
<p>Examples of sources of cash:<br />
- Sales of goods.<br />
- Sales of services.<br />
- Rents.</p>
<p>Examples of uses of cash:<br />
- Purchase of goods.<br />
- Wage expenses.<br />
- Rents paid.<br />
- Other expenses.</p>
<p>Example of cash flow:<br /><img src="https://economicpoint.com/sites/default/files/cash-flow.png" alt="cash flow statement" style="width:558px;height:578px" /></p>
<p>As seen on the above example, the cash flow can be divided into 3 sections:<br />
- Operating cash flow: cash flow from the main activities of the company (operations).<br />
- Investing cash flow: cash flow results from the purchase or sale of capital assets, not directly related with the main activities of the company.<br />
- Financing cash flow: cash flow results from borrowing, repaying or raising of money.</p>
<p>The cash flow statement is an essential statement of the short term situation of a company. It gives information about the profitability of a company and about the need of external financing. </p>
<p>Additionally, the cash flow statement is used to make other useful reports and indicators. For example:<br />
- The cash flow can be used to calculate the internal return rate of the invested funds.<br />
- The cash flows can be used to measure long term tendencies of the different components of the cash flow.<br />
- It can be used to prevent the need of external financing. </p>
<p>As we can see, the cash flow statement is an essential report of every company. Is closely related with the short term solvency of a company, but is also used by manager to make strategic decisions.</p>
</div></div></div><section class="field field-name-field-tags field-type-taxonomy-term-reference field-label-above view-mode-rss"><h2 class="field-label">Tags: </h2><ul class="field-items"><li class="field-item even"><a href="/terms/cash-flow" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Cash flow</a></li><li class="field-item odd"><a href="/terms/reports" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Reports</a></li><li class="field-item even"><a href="/terms/financial" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Financial</a></li><li class="field-item odd"><a href="/terms/excel" typeof="skos:Concept" property="rdfs:label skos:prefLabel" datatype="">Excel</a></li></ul></section>Wed, 11 Mar 2015 17:21:18 +0000EconomicPoint81 at https://economicpoint.com