How discounted cash flows works, and how it differs from the "cash in hand" model.
DCF: What is it?
Discounted cash flows is a method of business valuation that uses the "time value of money" to predict what a project's value will look like in the future. This kind of "crystal ball" tool is very useful to project managers who need to anticipate either a fully funded timeline or a lack of funding down the road. In discounted cash flows, the future cash flows revenues are valued at their "future values", which means the tools and methods allow for changes in taxation, inflation or other variables.
What discounted cash flows tools provide, is assistance with the accuracy of future projections. It's up to the project manager to come up with the conceptual "cash flows" and identify where those will be coming from; once that's done, the discounted cash flows tools can assist with valuation of those flows to simulate what the coffers may look like at any stage of implementation.
"Cash in Hand": Business Security
If you regularly attend management meetings where financial officers present, you may have already heard someone "cheerleading" with cash in hand figures. That's because the use of cash in hand is a provision against the lack of future cash flows. It's an assessment of how a company would work if cash flows were suddenly cut off. The figures for cash in hand can provide a very impressive portrait of a company or project as amazed onlookers gasp over the ability of a project or company to "fund itself": in reality, the figures are just an assessment of present value, but they can be good for giving involved staffers confidence. But, in looking ahead, discounted cash flows and other business valuation will help predict what will generally happen given known levels of cash flow, and that's often more informative than the "what-if" scenario that cash in hand estimates are based on.
Types of Discounted Cash Flows
For using discounted cash flows to predict project funding, there are a number of options, including these standard valuation techniques including Flows to Equity, Adjusted Present Value, and Weighted Average Cost of Capital. These fulfill different sub-functions of what discounted cash flows and business valuation does on a management level. APV, also known as Net Present Value, accounts for changes in valuation over time by calculating the "now" value of an asset. The WACC model, on the other hand, focuses on how much a project or company must make in order to "clear", or in other words, to be able to pay off creditors. For all of these and more, find DCF tools that allow your projects to go forward confidently with past, present and future worth accounted for.
For more information to aid in understanding and controlling project cash flows read:Using Earned Value Management to Control Cash Flows by eschulze