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Cash flows are different than net income.
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Cash flows appear on the statement of cash flows. Cash flow will estimate the ability of the company to pay long-term debt, its liquidity, and its ability to grow. A cash outflow can be money paid or increased cost expenditures from capital investment. A cash inflow can be money received or cost savings from a capital investment. Cash flow is money coming into or out of the company as a result of a business activity. The payback period is calculated when there are even or uneven annual cash flows. The payback method is limited in that it only considers the time frame to recoup an investment based on expected annual cash flows, and it doesn’t consider the effects of the time value of money. One way to focus on this is to consider the payback period when making a capital budget decision. Therefore, a company would like to get their money returned to them as quickly as possible. This extended length of time is also a concern because it produces a riskier opportunity. The longer money is unavailable, the less ability the company has to use these funds for other growth purposes. This can be useful when a company is focused solely on retrieving their funds from a project investment as quickly as possible.īusinesses do not want their money tied up in capital assets that have limited liquidity. In other words, it calculates how long it will take until either the amount earned or the costs saved are equal to or greater than the costs of the project.
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The payback method (PM) computes the length of time it takes a company to recover their initial investment.