There are different cash flow metrics available for analyzing projects such as total cash flow and incremental cash flow. Total cash flow is used for assessing the viability of a whole project. Incremental cash flow is used more for assessing the cash flow impact of making changes in an ongoing project.
Incremental Cash Flow
Incremental cash flow is an investment-return measurement technique that gives a manager an idea of the benefits of making an investment or change in management policies. For example, a manager is evaluating the effects of purchasing new business software now versus a year from now. The business software now costs $2 million, but will cost $1 million a year from now. However, the new business software will allow the company to become more efficient and allow it to cut its $500,000 a year expense of the outsourcing of administrative tasks.
The incremental cash flow of buying the software right now is the change in cash flows of the business software project. The company will spend an extra $1 million for the software but save $500,000 a year. A savings of $500,000 minus the extra cash outflow of $1 million dollars leads to incremental cash flow of $500,000. Therefore the company should not buy the business software now and should wait one year.
Total Cash Flow
The total cash flow describes the cash generated from a project or company. The total cash flow can describe past or future events. For example, a company generated cash flows of $1 million three years ago, $2 million two years ago and $3 million last year. To find the total cash flow generated over the past three years, add the cash flow of the past three years together for a total of $6 million. To describe the total cash flows expected, you have to project the cash flows of a project or company over a certain time frame and add them together. The sum of the cash flow projected is the total cash flow projected over the time frame.
Both incremental cash flow and total cash flow are cash flow measurements, but they measure different cash flows. Incremental cash flow measures the benefits of a change in the operating plan or business. Total cash flow measures the cumulative cash flows over a certain period of time or specific project.
Incremental cash flow is very beneficial for use in projects, investments or policy changes at a company. It will allow a manager to quickly get an idea of whether or not it is worth taking on a project or investment. A positive incremental change in cash flow usually indicates that the company should invest in the project or change in question.
Note, however, that incremental change in cash flow does not consider the risk of the incoming cash flows. If the cash flows are not guaranteed and are high risk, then even a positive incremental cash flow may not be sufficient in deciding to pursue the change. It may be necessary to assess the odds of generating the different cash flows first.
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