Incremental cash flow analysis is the increase or decrease in cash flows that are specifically attributable to a management action. So if your management team is attempting to improve the capacity of a machine, the cash flow resulting from the use of that machine is not where you should stake your decision, but rather the incremental cost of improving the machine, and the incremental revenue that results from having additional volume.
For example, assume that a machine produces 1,000 cans per hour, and an upgrade to the machinery will result in an increase in the theoretical capacity to 1,500 cans per hour, for an incremental change of 500 cans per hour. The cost of the upgrade is $100,000, and the profit from each can is $.04. Since the machine runs 8 hours a day for five days per week, the increase in volume will result in an added cash inflow of $41,600, which is calculated as follows (Example from Accounting Tools):
(500 cans per hour) x $.04 = $20 per hour incremental cash inflow
= ($20 per hour of cash inflow) x (40 hours per week) x (52 weeks per year)
= $41,600
This incremental investment translates into a payback of 2.4 years, which is a reasonable return period for most investments. However, from an incremental perspective, why not run the machine a bit longer to obtain the same production that the machine would yield with the enhanced equipment? This example shows that you must review the specific cash flows that will change as a result of a specific management decision to see if it will result in a positive incremental change in cash flows, ultimately increasing your ROI.
Silverware builds solutions with Microsoft Dynamics NAV giving you enhanced management capabilities for your financial and operational departments. Microsoft Dynamics NAV is the most widely used mid-market ERP software for manufacturing and wholesale distribution in the world. Silverware works throughout the southwest with a focus on companies located in Arizona (AZ) plus Nevada (NV), Colorado (CO), New Mexico (NM) and Utah (UT).
By David Thikoll with Silverware, a Phoenix, Arizona Microsoft Dynamics NAV Partner
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