Have you been losing sleep figuring out the best way to maximize profitability and minimize risk on your business investments? Stop tossing and turning. Relax and go with the flow.

Cash, that is. Take a look at your cash flow, or what goes into and what goes out of your business. Positive cash flow is the measure of cash coming in (sales, earned interest, stock issues, and so on), whereas negative cash flow is the measure of cash going out (purchases, wages, taxes, and so on). Net cash flow is the difference between your positive cash flow and your negative cash flow, and answers that most fundamental of business questions: How much money is left in the till?

To grow your business, you need to make key decisions about where to invest your money over the long term. Microsoft Excel can help you compare options and make the right choices, so that you can rest easy both day and night.

In this article

Asking questions about capital investment projects

Should I invest even more in an ongoing project, or is it time to cut my losses?

Now take a closer look at each of those projects, and ask:

What are the negative and positive cash flows for this project?

What impact will a large initial investment have, and how much is too much?

In the end, what you really need are bottom-line numbers that you can use to compare project choices. But to get there, you must incorporate the time value of money into your analysis.

My papa once told me, Son, it’s better to get your money as soon as possible and hold on to it as long as possible. Later in life, I learned why. You can invest this money at a compounded interest rate, which means that your money can make you more money — and then some. In other words, when cash goes out or comes in is just as important as how much cash goes out or comes in.

Answering questions by using NPV and IRR

There are two financial methods that you can use to help you answer all of these questions: net present value (NPV) and internal rate of return (IRR). Both NPV and IRR are referred to as discounted cash flow methods because they factor the time value of money into your capital investment project evaluation. Both NPV and IRR are based on a series of future payments (negative cash flow), income (positive cash flow), losses (negative cash flow), or no-gainers (zero cash flow).

NPV

NPV returns the net value of the cash flows — represented in today’s dollars. Because of the time value of money, receiving a dollar today is worth more than receiving a dollar tomorrow. NPV calculates that present value for each of the series of cash flows and adds them together to get the net present value.

The formula for NPV is:

Where n is the number of cash flows, and i   is the interest or discount rate.

IRR

IRR is based on NPV. You can think of it as a special case of NPV, where the rate of return that is calculated is the interest rate corresponding to a 0 (zero) net present value.

NPV(IRR(values),values) = 0

When all negative cash flows occur earlier in the sequence than all positive cash flows, or when a project’s sequence of cash flows contains only one negative cash flow, IRR returns a unique value. Most capital investment projects begin with a large negative cash flow (the up-front investment) followed by a sequence of positive cash flows, and, therefore, have a unique IRR. However, sometimes there can be more than one acceptable IRR, or sometimes none at all.

Comparing projects

NPV determines whether a project earns more or less than a desired rate of return (also called the hurdle rate) and is good at finding out whether a project is going to be profitable. IRR goes one step further than NPV to determine a specific rate of return for a project. Both NPV and IRR give you numbers that you can use to compare competing projects and make the best choice for your business.

Choosing the appropriate Excel function

Which Office Excel functions can you use to calculate NPV and IRR? There are five: NPV, XNPV, IRR, XIRR, and MIRR. Which one you choose depends on the financial method that you prefer, whether cash flows occur at regular intervals, and whether the cash flows are periodic.

Note     Cash flows are specified as negative, positive, or zero values. When you use these functions, pay particular attention to how you handle immediate cash flows that occur at the beginning of the first period and all of the other cash flows that occur at the ends of periods.