An investment proposal counts every accounting saving as cash and excludes the working capital needed to support growth. It includes a past feasibility study because the project sponsor wants to recover the expense.
The resulting model may be detailed but answers the wrong question. An investment case needs the cash flows that change because the decision is made.
Define the counterfactual
Compare the project with a credible alternative: continue, repair, replace differently or stop.
The “do nothing” case is not always zero. Existing assets may need maintenance, lose capacity or create future obligations.
A hypothetical replacement machine should be compared with the actual cost and capability of keeping the existing machine, including relevant disposal or replacement timing.
Separate sunk and opportunity costs
Past spending that cannot be changed by the current decision is sunk. It may explain the project’s history but should not determine its incremental value.
A resource already owned can still have an opportunity cost. Using a building for the project may prevent a sale, rental or another valuable use.
Include cannibalization and effects on other business where material. Revenue moved from an existing offer is not entirely additional.
Translate operations into cash
Identify volume, price, variable cost, support, quality and implementation effects. State how the proposed change produces each benefit.
Time released becomes cash benefit only through a defined consequence. An allocated hourly cost is not automatically avoidable.
Include ramp-up, training, downtime and the resources needed to sustain the new method. A best-cycle demonstration does not establish annual savings.
Model tax consistently
Depreciation is noncash but can affect taxable profit. Tax losses, deductibility and timing require an assessment of the actual circumstances.
| Simplified hypothetical year | Value |
|---|---|
| EBIT | €200,000 |
| Tax at 25% | −€50,000 |
| After-tax operating profit | €150,000 |
| Add back depreciation | €50,000 |
| Capital expenditure | −€120,000 |
| Additional operating working capital | −€30,000 |
| Free cash flow to the firm | €50,000 |
The example assumes the modeled tax is paid and usable in that period. It is not a universal jurisdictional rule.
Include the whole lifecycle
Add the initial working-capital commitment, later reinvestment, disposal proceeds and relevant end-of-life costs.
A working-capital release at the end should reflect what is actually collectible or recoverable. Stock does not necessarily convert to cash at its recorded value.
Recoverable VAT may be excluded from economic cost while still affecting short-term cash timing. Nonrecoverable amounts and different recovery conditions require separate treatment.
Keep financing treatment coherent
For firm cash flow discounted at WACC, financing flows are normally modeled separately. Do not deduct loan repayments as operating investment cost or count a financing benefit twice.
Reconcile the appraisal with the funding schedule so that both views describe the same project.
For the next business case, ask an operational owner and a finance owner to trace each cash line to a decision or measurable mechanism. Remove unsupported benefits and add omitted commitments.
A reliable cash model is a transparent explanation of what changes, when it changes and why.