Estimating cash flows — the investment outlays and the cash inflows after the project is commissioned — is the most important, but also the most difficult step in capital budgeting. Estimating cash flows process involves many people and numerous variables.
A project which involves cash outflows followed by cash inflows comprises of three basic components. They are,
- Initial investment: Initial investment is the after-tax cash outlay on capital expenditure and net working capital when the project is set up.
- Operating cash inflows: The operating cash inflows are the after-tax cash inflows resulting from the operations of the project during its economic life.