BUSINESS
for 4 years. This means that the first practice
would calculate net cash flows over a 3-year
period, while the other would use a 4-year
period.
So why is it important to forecast the net cash
flows for each year? Simply put, because R100
today is worth more than R100 in the future. This
is because:
•
•
•
The R100 could be put in a savings account
to generate interest
The risk of receiving R100 in the future is
much greater
Inflation means that one can purchase less
at a later stage
Using the inflation rate of 5% as a benchmark, the net cash flows
for Project A would be:
Put another way – would you rather someone
give you R1 million right now, or in another 5
years? How are future cash flows discounted?
If I wanted to receive R1,000 in 4 years’ time at an
interest rate of 6%, I would have to invest R792. If
this was flipped around, we could say, then, that
in 4 years’ time, R1,000 will equal R792 at today’s
rates.
Not so long ago, finance people would use
pages and pages of tables like the one below.
Now, of course, it’s much simpler using either
a spreadsheet program or the internet. In other
words, at today’s prices Project A would have a
negative cash flow of R103,283.
Clearly Projects A and B are money wasters, but
even Project C may not be a wise investment
with such a low net cash flow. In fact, it might
be a better investment to place the R80,000 in a
savings account at the bank.
5. Conclusion
Capital investment within the veterinary industry
needs to move towards financial rationalisation,
where decisions are made based on the cash
inflows that a project yields.
The same sluggish economy that is making
this necessary for vet practices is making their
customers seek less pricey consults, resulting in it
becoming increasingly difficult to generate direct
cash flows from new machinery and equipment.
Present
Value
Factor
Project A
Present
Value
R
R
Initial Investment -700 000 x 1.00 = -700 000
Net Cash Flow for Year 1 246 000 x 0.95 = 234 192
Net Cash Flow for Year 2 155000 x 0.91 = 140 585
Net Cash Flow for Year 3 50 000 x 0.86 = 43 200
Net Cash Flow for Year 4 40 000 x 0.82 = 32 920
Net Cash Flow for Year 5 40 000 x 0.78 = 31 360
Net Cash Flow for Year 6 20 000 x 0.75 = 14 920
Net Cash Flow for Year 7 140 000 x 0.71 = Total Cash Flows -9 000
99 540
-103 283
When the exercise is repeated for Projects B and C, this is the
revised summary of all the Projects:
Project A (R) Project B (R)
Project C (R)
Initial Investment -700 000 -100 000 -80 000
Net Cash Flow for Year 1 234 192 -61 880 19 992
Net Cash Flow for Year 2 140 585 -45 350 17 233
Net Cash Flow for Year 3 43 200 -25 920 14 688
Net Cash Flow for Year 4 32 920 123 450 12 345
Net Cash Flow for Year 5 31 360 n/a 10 976
Net Cash Flow for Year 6 14 920 n/a 18 650
Net Cash Flow for Year 7 99 540 n/a n/a
Total Cash Flows -103 283 -109 700 13 884
On a broader level, practices need to be run on sound business principles to maintain and improve profitability in a
rapidly changing veterinary landscape. An increasing amount of attention is being paid to performance – the opex
component – and it is time that capex decisions are made with sound financial reasoning.
Issue 05 | NOVEMBER 2018 | 25