1. Introduction

Forecasting the financial statements of your project is the first step to undertake a valuation. But knowing that your project will have a positive net income throughout the years is not enough to say that it has viability. You have take also into account the investment, how will it be financed, if and how the net income transformes into cash-flows, and finally, how will the economic benefits of your project evolve throughout the years (or any other time segmentation that you may be looking at).

Example – Profitability does not assure project viability

Fernando and Romain estimate that their future company requires an initial investment of 30.000.000€ to get its business running. They also estimate that their company will have a constant positive net income of 100.000€ every year. Is this project interesting for an investor?

  1. Having a 100.000€ of net income does not mean that the company will be receiving a net sum of 100.000€ every year. Net income is different from the concept of cash flow; cash-flow is the stream of cash and equivalents that the company receives and disburses. A company may have a positive net income, but if it fails to collect its invoices from its clients the cash flow that it receives is less than the net income. You will rarely find that the net income is equal to the cash flow of the company.
  2. Even if the net income is exactly equal to the cash flow, the investor will only be paying back his investment in 300 years (30.000.0000 / 100.000). That is a payback period that nobody is interested in having.
  3. In the above number, it was not considered that investors (just like anyone) cherish more holding money today than holding the same amount of money in a year into the future; that concept is related to what is called the cost of capital. It means that the 100.000€ received 10 years after the project started are not as significant as the 100.000€ received in the first year. Ask yourself which would you prefer: to receive 100.000€ 10 years from now or receiving 85.000€ today; you are most likely going with the 85.000€; although it does not apply to everyone the same way.
  4. Going back to the first question: is this a good investment?
  5. It likely is not.

You cannot state if a project is viable only based on the net income. The example demonstrates why you need to study the financial feasibility of your project or company. In this tutorial, we will be explaining different concepts of corporate valuation with emphasis on the Discounted Cash Flow of Free Cash Flows to the Firm approach, which is used with CASFLO APP. Valuation is a reasonably large field of study which is mostly applied to existing companies, but its principles also apply to entrepreneurship projects if it is considered the specificities of an entrepreneurship project. Do note that financial valuation is not the sole form and valuation and it does not attribute an sentimental value, environmental value, social value or any other type of appraisal that a person can have from a company or a entrepreneurship project.

Next Section: 2. Valuation