Importance of Cash Flow Diagram

The cash flow diagram is the most important and essential element of financial analysis. A proper and accurate cash flow diagram should be constructed and tested before an attempt is made to perform the financial analysis. Indeed, with today's special handheld calculators and personal computer spreadsheets, the financial analysis is completed very quickly without much financial knowledge required on the part of the operator. But, the construction of a cash flow diagram requires a deep understanding of the financial situation of the project or problem at hand. No computer can provide the right answer if the cash flow diagram is not constructed properly and accurately.

All the cost and benefit components occurring during the course of the proj ect and their time of occurrence should be accurately presented in the cash flow diagram. Any costs related to this proj ect incurred before the zero time of the analysis are considered "sunk cost" and do not enter in the analysis. This is a very important point to remember. It does not mean that in our future activity we should not consider taking a course of action to recover the sunk cost. It means that the fact that we have spent money up to this point should not cause us to continue a non-profitable project; in other words, "don't send good money after bad money". The interest rate i is assumed to be constant for the duration of the project or operation of the system under analysis. A typical cash flow diagram is presented in Fig. 1.3

Initial investment

Time

Initial investment

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Responses

  • daniel
    What is the importance of cash flow diagram?
    9 months ago

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